The Urgent Case for a Big Stimulus

Making banks solvent was never going to be all that was necessary to make the American economy whole again. The inexorable recessionary process is now well on its way. We will learn more about how far and fast we are sinking in the next couple of weeks, as the data become more clear. But reports of serious lay-offs are widening. Few are borrowing, or can borrow. There is little spending power out there. Except for the late 1990s, Americans simply did not make enough to get by without borrowing. In the 2000s, wages for typical Americans did not go up at all, nor did family income. Now they will go down. Where will the spending power come from? Living on a credit binge is over.

Perhaps the Paulson plan will work and banks may have adequate capital. But they won't lend it. This is by now an ancient paradox, one forgotten time and again. Businesses won't borrow in times of recession unless they see signs that sales are coming back. Of greatest irony, even Milton Friedman did not believe solving the banking crisis in the early 1930s was enough. Friedman's position is widely misunderstood. Supposedly knowledgeable Harvard historians don't seem to know this. Maybe even some liberal economists don't, either. Friedman argued that the Federal Reserve had to step on the gas. Stopping a run on banks was not enough.

To repeat, making banks whole is at best half the solution. The nation needs spending power. But monetary policy a la Friedman won't be nearly sufficient, either. I don't mean pumping up the money supply. That was discredited some time ago. The Fed doesn't control it as closely as popular myth suggests, and its relationship with growth is highly variable.

Rather, we've escaped recession after recession in recent decades by partly reducing interest rates. Now, however, interest rates are very low. There's not much left in the monetary tank. Moreover, as Nobelist Lawrence Klein has argued repeatedly, stimulus works best when both guns are firing--monetary and fiscal stimulus. The latter means growing budget deficits.

Given the breadth and depth of the problems, we need a lot of federal spending. Sound like John Maynard Keynes? You bet. The collapse in stocks and housing will have an enormous depressing "wealth" effect on consumption and investment. A shock to demand would require a spending increase of two percent of GDP, anyway.

So let's say $300 to $600 billion is what we need pumped into the economy -- and fairly soon. The good news is that money can be directed towards the public investment in such dire need of advancing: infrastructure, alternative energy development, pre-K education, broadband capacity. Much of this will create domestic jobs. The unemployment insurance system also badly needs updating and broadening. States and local government are shutting down services and need money badly.

The bad news is that the anti-government attitudes are still with us, even if Obama wins. The fear of big deficits will restrain liberal economists for recommending what is necessary. The nation is still locked into the ideology of the past and the sense that American cannot afford to do what it must.

The opposite is true. If we don't stimulate the economy, tax revenues will fall far faster and deficits rise, anyway. But they won't be the deficits of constructive investment. They will be the deficits caused by unnecessarily lost income and wealth. It's a difficult but necessary choice. Will the new president make it?

Comments

[uncleentropy]

Not sure Keynes would be comfortable with the timing of a stimulus of this size. For him, it was a tactic to be employed when the deficit-producing results of stimulus could be overcome relatively quickly, not triage to an economy that is already suffering the unmitigated effects of poorly planned, obscenely excessive "stimulus packages" of the last eight years.

[leftLibertarian]

Have Comrade Paulson mail me a $250,000.00 check.

[Pdubya]

Given that we are a consumer/debtor nation now and not a production/savings based economy, "stimulating " the economy will just ensure the further destruction of our dollar through hyperinflation. You want to spend on infrastructure to stimulate jobs? O.K. We'll have to cut spending doubly elsewhere to restore confidence in our dollar to make a real difference. Credit doesn't come from more credit or deficit spending, it comes from savings. I could use a dose of Hayak and Von Mises right now.

[DuganS1]

Stimulating the economy will help the dollar because a nation's currency is largely determined by relative economic strength. If the US economy is weak and the Euro zone is strong, people will want Euros. If the US economy is notably stronger than the euro zone economy, people will want dollars over euros regardless of the higher budget deficit of the US.

[Marco Trbovich - Huffpost Blogger]

Learned yesterday of a new car dealership here in Pittsburgh that is literally begin called daily and asked for their payment on the cars they have floor planned. Little wonder, car dealerships, some of them long in business, are folding up. So current behavior comports with your characterization of the banks' history of not just lending because somebody -- in this case us taxpayers -- enriches their coffers.

[DuganS1]

While real median income went down, real disposable income went well up over the decade. Second, median income actually went up but was mitigated by inflation. Well, inflation is subsiding now, bringing up real wages. The drop in the gas prices alone frees up an extra $20 billion a month in spending for Americans. In a little over five months time, this will equal the amount of money in rebate checks handed out earlier this year. About the stimulus proposals above, infrastructure spending is probably a good idea now as commercial construction has weakened substantially over the last months and heavy machinery companies will be seeing a dropoff in export orders going forward. The country could also get a lot more bang for its buck then just three months ago because prices for steel and aggregate have come down dramatically. As for alternative energy, it depends on what exactly the investment would be for as demand for alternative energy will go down along with oil prices. I don't understand the investment in broadband capacity either as telecomm companies have been reducing investment spending dramatically because of weakening demand. The last thing we need is to glut the market in a time of low demand.