Why The Stimulus Is Too Small
There's a hurricane coming. Meteorologists aren't sure what category it will be but know it will be the worst in generations. There's a warehouse full of sandbags.
What do you do?
Some folks in town are arguing that using the entire warehouse would be wasteful and leave the next generation without any sandbags. Half the sandbags might be enough to stop the surging waters, they argue.
Then again, half might not be enough.
"Use them all," suggests economist James Galbraith. "If it turns out that you've used too many, then you've got extra sandbags. Big deal. If you use too few, they're all destroyed."
Yet as the economic hurricane hits, President Obama and the U.S. Congress - driven by centrist senators from both parties - have decided to leave a few sandbags in the shed, hoping the waters won't rise too high.
The stimulus package scheduled to be voted on Tuesday, say contrarian economists, is simply too small to withstand the economic storm that's coming.
It's a matter of basic math, says economist Dean Baker of the Center for Economic and Policy Research. The economy is currently losing - annually -- $450 billion in housing wealth, $650 billion in consumer spending and $150 billion in commercial real estate value.
"You're talking about a gap on the order of twelve-hundred-fifty billion dollars, and we're trying to plug that with four-hundred-something, so we've got a long way to go," Baker says. (The stimulus package of roughly $800 billion doles out spending and tax cuts over two years.)
Galbraith, too, says that demonstrating that the stimulus is too small is a matter of basic math. The $400 billion it will inject into the economy each of the next two years is equal to about two to three percent of GDP, he noted. But the economy is falling at a much faster rate, projected at eight percent a year by the CBO - and that projection, again, doesn't account for the financial collapse.
If it's too small, how is it, then, that economic models like the Congressional Budget Office's show that the economy will turn around sometime in 2009 or 2010?
The harsh reality: they're just guessing. And they're guessing based on economic models, says Galbraith, that have been built post-World War II and don't take into account the collapse of the financial sector. Instead, they assume the credit markets will be there to help ease the nation out of the downturn.
"We're in a unique crisis in the financial sector, something we've never seen in our lives: a crisis of the insolvency of the largest banks," Galbraith says. "Those banks, until they are reorganized and restructured, will not be part of a new credit expansion."
Galbraith says he was unsurprised that the banks didn't loan money after getting bailed out, because they were still so far under that they were holding on to stay alive. If you had bills coming due totaling $100,000, and I gave you $5,000, would you turn around and lend that to someone else? (Especially in this economy.)
For the stimulus to be able to turn around an economy spiraling down at that rate, the money injected into the economy would have to be multiplied many times over. But, Galbraith says, the economy is currently stuck in a "liquidity trap." People aren't spending because they're insecure about the future; companies aren't borrowing and expanding because the business climate looks stormy; and banks aren't lending because when the economy's tanking almost everyone looks like a bad credit risk. The multiplier effect for a tax cut to business and the middle-class, Galbraith guesses, will be close to zero, because the money will be saved or used to pay down debt.
With the banks in collapse, the CBO, then, is modeling for a situation that doesn't exist in reality. The running assumption among pundits and politicians - that the economy will turn around in 2010 or thereabouts - assumes that this recession is similar to previous recessions in which the financial sector and credit markets didn't collapse.
"We are working with a set of economic projections which assume, for mechanical reasons, that the economy is going to start turning around at the end of this year. There is no analytical foundation for that," Galbraith says. "Those models that are based on the period after 1945 aren't going to work. They just aren't going to be right."
The current crisis is qualitatively different than any recession that the current projections are based on. If they're wrong, then - given the small size of the stimulus -- there will be no turnaround in 2010. Instead, the economy will careen out of control, unemployment will continue to rise, production will slow, etc. The White House acknowledges the severity.
"We're in a very serious situation," Obama's economic adviser, Lawrence Summers, told ABC News' "This Week." "This is worse than any time since the Second World War. It's worse than, I think, most economists like me ever thought we would see."
Democrats, including President Obama, have referenced the CBO modeling by making the claim that there is a gap of one trillion dollars between actual economic production and potential economic production. If that's the case, then it would seem that the stimulus should be enough to turn things around.
"They're taking the word of technicians who are running a model that has no financial sector in it," repeats Galbraith, noting that during the Great Depression "the collapse of the banking sector was critical to the collapse and lack of resilience in the economy." There was no economic modeling being done in the 1920s or 1930s, however.
Not even Galbraith, however, is absolutely certain that he and others who are similarly sour on the size of the stimulus are correct. We live in an uncertain world, as Robert Rubin likes to say.
But think of it like Pascal's Wager. Blaise Pascal famously argued that you might as well believe in God because if you're wrong, all you've done is waste a few Sundays. If you wager there's no God and you're wrong, well, God help you.
In the same way, if the government follows the Galbraithian advice to go big and spends everything it can to turn the economy around and it goes too far, the worst thing you get is some inflation - which can be pulled back with interest rate hikes - and a higher national debt. (The Senate version raises the debt ceiling to $13 trillion.)
But what if they're right? There are more ways to harm children and grandchildren than saddling them with debt, such as, say, leaving them with a drastically lowered standard of living and an unstable world.
Of course, the stimulus number isn't driven by economics, but by politics, despite occasional attempts to assert otherwise.
"I think it will be below 800 [billion dollars]," said Nebraska Sen. Ben Nelson, the most vocal Democrat calling for a trimmed down stimulus. "For me it's not symbolism, it's an economic matter. At some point it's just too big."
That façade, however, stood erect for about five seconds. Asked by the Huffington Post if that meant he thought 800 billion, from an economic standpoint, was the specific point at which it was too big, he smiled and said, "It's whatever gets 60 votes, 61 votes."
Politics being the art of the possible, Democrats shaved money from what was already a small stimulus in order to get Nelson's and Republicans' votes in the Senate. The GOP was able to control the messaging and the media focused on spending projects that Republicans ridiculed. Only when Nelson and his fellow centrist began proposing cuts to popular programs did Democrats retake control.
House Speaker Nancy Pelosi (D-Calif.) has spoken out harshly against those cuts, saying they "do violence to what we are trying to do for the future," setting up a confrontation between her chamber and the Senate as the two bills are to be reconciled.
With the United States government close to roughly $12 trillion in debt and contemplating tacking on another $800 or so billion, the two bodies will wrestle all week over some $40 billion. By congressional standards, that's the change in the couch cushions.
Senate Majority Leader Harry Reid said that he wanted to go bigger, too. "Am I satisfied that this package is big enough? Keep in mind, it's approaching a trillion dollars," said Reid Friday night. "It's a piece of legislation that is job creating. Did we get everything we wanted? No, we didn't."
Asked if there was a fear among Democrats that the stimulus wasn't big enough, Sen. Joe Lieberman responded, "Oh yeah. That's what we've argued all along. It has to be substantial."
Obama, too, began the push for the stimulus saying that economists had called for more than a trillion-dollar package and that the nation couldn't afford to undershoot the mark.
Yet here we are. Because the stimulus is too small, argue the economists, it will cost people jobs. "My first cut says that the changes to the Senate bill will ensure that we have at least 600,000 fewer Americans employed over the next two years," wrote Nobel-Prize winning economist Paul Krugman Sunday.
Eileen Appelbaum, director of Rutgers University's Center for Women and Work, is an economist with a ground-level view of the damage being wrought
"It needs to be bigger, if you just take a look at the amount of household spending that is lost because of the decline in homes, equity and 401(K)s," she says.
She said that her own daughter, who is upper-middle class, has sharply cut back spending even on groceries. "At the lower ends, I'm sure that people are reducing what they're eating. At the higher ends, they're reducing what they're wasting," she says.
So far, she says, health care has remained one of the few sectors that hasn't been hit hard by layoffs. But the Senate compromise slashes money to shore-up state budgets, meaning that states will be required to cut back on health care spending. The government, she says, ultimately funds more than half of all that spending.
"If you look at it from the point of view of the states, this money is desperately needed," she says. Without government payments, countless private and nonprofit health agencies would be forced to close. "I mean, [the Senate] cut money out of the program for feeding infants."
Even if it's too small, the economists say, the stimulus will still create millions of jobs and we may see job losses decline to a few hundred thousand a month rather than the 600,000 we saw in January. Something, they say, is better than nothing.
It's a point Democrats make repeatedly. "When history is written, historians are going to point out that the United States Congress and President Obama, in 2009, in facing the recession and joblessness in America, did the right thing in contrasting it with the Great Depression," said Sen. Max Baucus (D-Mont.), chairman of the Finance Committee. "During the Great Depression, the president and Congress stood by. They watched."
The history of efforts to save the economy is still being written. President Obama has said stimulus spending is one leg of a three-part approach that will also include efforts to stem the foreclosure crisis and stabilize the financial sector. The push for the latter effort is to begin Tuesday, with the release of a plan announced by Treasury Secretary Tim Geithner that is expected to cost hundreds of billions.
But if the economists are right, the stimulus leg of that stool will need to be returned to. For Appelbaum, if this package shows results, it could help Obama argue for a second one. The president could cite the unanimous Republican opposition in the House and the strident objections of GOP senators that cut the stimulus down in size, she says.
"The most shocking thing to me has been to see the Republican Party playing chicken with the economy," says Appelbaum.
Galbraith hopes that Obama won't play along and suggested a rethought approach next time around. "Right from the beginning, the discussion was, What's your number?" Galbraith, who was asked that question himself by Obama's transition team, says. He argues that the president should instead do everything that needs to be done and add it up when the storm passes.
"My position is: do everything," he says. Do everything and then see what the results are, and when you're sure you've got the economy going again, you can cut back."
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February 9, 2009 12:23 AM