The $789 billion stimulus bill passed today. As expected, the Republican leadership carped about the cost. Senate Minority Leader Mitch McConnell complained, "We've heard a lot from our friends about the danger of deficits over the past few years...Americans are wondering how we're going to pay for all this." In case this message was too abstract for average Americans, McConnell supported his point with a common sense analogy, "Any parent knows you don't buy a new car and plan the summer vacation before you set the family budget for the year."

The trouble with common sense analogies is that sometimes they're wrong. My father is a master of his family budget, but if we were to apply his maxims to the Federal budget, we'd quickly bury our ailing economy.

According to McConnell's Parent Principle, you buy a new car when you have the money to afford one and make do with the old one when you don't. The Parent Principle makes a lot of sense for individuals, but when everyone practices it at the same time, it can pitch the economy into a vortex. When the economy slips into recession or worse, people wisely limit their spending, which causes demand for products like new cars to go down. Lower demand causes car manufacturers and other businesses to scale back production or go bankrupt, either of which means layoffs. Laid off workers have no money for new cars and other products, so demand falls further, leading to even lower production, then more layoffs, and so on.

During such a crisis, the government is the only entity with the clout to reverse the spiral, and to do so, it has to raise its middle finger to the Parent Principle and buy itself a really expensive car that it can't afford. The government's spending increases demand, which causes businesses to increase production, which means that they have to hire workers, which gives people the money to start buying their own cars again.

Early in the Great Depression, Herbert Hoover followed the Parent Principle by raising taxes and cutting spending in order to balance the budget. His thriftiness made the depression worse. F.D.R., following the recommendations of the economist, John Maynard Keynes, did the opposite. His government took on massive debt to finance the New Deal, which injected much needed money into the economy and has been widely credited with helping to reverse the downward spiral.

The Parent Principle is just as wrongheaded when the economy is strong. When business booms, the economy can spiral upwards, as high demand encourages businesses to increase production, forcing them hire more workers and, when there aren't enough workers, raise wages. Higher wages stimulates higher demand for new cars and other products according to the Parent Principle, which causes businesses to increase production, and so on.

That doesn't sound so bad. What's wrong with higher wages? The problem is that higher wages lead to higher prices, that is to say, inflation. Rampant inflation can suffocate a growing economy and reverse the upward spiral. The government has gotten pretty good at controlling inflation, so haven't seen that problem lately, but we still have a big problem with economic bubbles in which everyone becomes overconfident and spends too much money on new cars or as we saw recently, new houses. When the economy grows too fast, prices for some assets like real estate or tech stocks becomes overinflated. Some people make a lot of money, but as my fellow dagblogger Deadman loves to intone, for every party, there's a hangover.

So when everyone else is spending it up and the Federal coffers are overflowing with tax revenue, the government should be cutting spending, raising taxes, and paying down the debt that it incurred when the economy was in decline.

Thus, while Mitch McConnell might be a prudent father, he's an idiot when it comes to the Federal budget. He said, "We've heard a lot from our friends about the danger of deficits over the past few years." His "friends" were right. The past few years, as the economy boomed, was exactly the right time to cut spending, raise taxes, and pay down the deficit. But that was then. Now, with the economy toppling into the abyss, we need put deficit cutting on hold and spend like crazy to reverse the spiral.

But McConnell is probably disingenuous in any case. When George Bush came into office, he inherited a budget surplus which he promised to return to rich taxpayers in the form of tax cuts--precisely the wrong thing to do in a booming economy. When the economy tanked after the dotcom bust, Bush switched principles and said that we had to cut taxes to stimulate the economy. Obviously, G.W. didn't give two hoots about the Parent Principle or the Reverse Parent Principle; he just wanted an excuse to cut taxes. McConnell, being a good Republican, is very concerned about the deficit now that Democrats are spending heavily, but where has his voice of prudence been for the past eight years?

There is also a lesson here for Democrats. Barack Obama has shrewdly realized that now is not the time to make good on his promise to rollback the Bush tax cuts, which would reduce consumption. That can wait for the next boom. When that boom comes, let's hope that Democrats don't treat the increased tax revenue like free money for a shiny new car. When the money is good, it will be time for the government to conserve spending a pay down that debt that we're now incurring.

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Cross posted at dagblog.com, where Deadman and DF debate the value of economic stimulus, and I swing this way and that, as usual.