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The case for fiscal stimulus
October 31, 2008
In this article for National Journal, I look at the arguments for a second fiscal stimulus. In light of the most recent data another fiscal boost is needed, and it had better be big.
This week, we learned that consumer confidence crashed in October to its lowest level since records began more than 40 years ago. This is far more worrying than a run of bad days on Wall Street. So severe a collapse in confidence — forecasters had expected a big drop, but not this big — is invariably the leading edge of a major recession, and unless governments act promptly and wisely, maybe a very prolonged one as well.
Several interacting forces are pressing the economy down. First, the credit system is broken. Good corporate borrowers cannot get financing to make new investments, or in some cases even to cover their payrolls and stay in business. Households are finding it harder to get loans as well, which is holding back recovery in the housing market. The government’s $700 billion bailout was intended to preserve the flow of loans. Without it, things would be even worse, but the situation is still anything but normal. The Treasury Department is telling banks that they must lend, lend, lend; but they are weak, and a process of sudden “deleveraging” — a collectively self-defeating effort to avoid risk by curbing credit — cannot be easily switched off.
Second, households are adding up their net worth. Their homes are valued at much less than they were a year ago, and prices are still dropping. Their 401(k)s have fallen by a third or more. Jobs that might have looked safe even a month or two ago no longer do. People suddenly feel much more vulnerable. To repair some of the savings shortfall, they are spending less, causing sharply lower sales of inessential goods. This, of course, is putting many companies under extra pressure. As firms cut their profit forecasts — which they are now doing en masse — and start to lay off workers, consumers become even more worried, and try even harder to cut back. And so it goes.
On top of all this is the fog of uncertainty about where the economy is heading. Until recently, many consumers had been telling themselves that the economy and the stock market would bounce back. They seem to have changed their minds. The parallels with the 1930s that the Bush administration drew to win support for the bailout were hardly reassuring. And lately, economists have been striving to outdo each other in the gravity of their assessments. In the end, all of this alarm seeps through.
A depression like that of the 1930s seems, even now, so unlikely as to be almost impossible — but in itself this is not very reassuring. Unemployment reached 25 percent in 1933. With government spending now much higher as a share of national income than it was back then, and with Congress, the administration, and the Federal Reserve Board all set on acting promptly and at sufficient scale, it is hard to see how a similarly massive and sustained contraction could happen again.
But unemployment in double digits — say half of what it was in the 1930s — is by no means unimaginable. Even if we are not headed for another Great Depression, we could easily be heading for the worst recession that most Americans have ever experienced. In fact, we most likely are.
You can read the whole article here. (The link expires in two weeks.)
Excellent column.
No question that a fiscal stimulus from governments is needed. As Paul Krugman noted in his column today:
“For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap — a situation in which the Federal Reserve has lost its grip on the economy.”
this is a liquidity trap. Lowering interest rates to zero or below zero with inflation will not do much without demand. Mr. Crook’s column is consistent with that analysis.
Let’s hope governments worldwide get their act together.
Posted by: Wendell Murray | October 31st, 2008 at 11:23 pm | Report this commentWhat is to be the cost of financing this flood of “In God We Trust” paper ? Topping up asset valuations of speculators, and consumer spending, is not productive investment.
Posted by: Anarchocynicalist | November 1st, 2008 at 8:48 am | Report this commentThe Chinese say that as exports shrink they will maintain growth by investment in agricultural productivity, and peasant wealth. How many US Treasuries will they want to buy in the next 3 years ?
The recent dollar strength has been due largely to deleverage selling and repatriation of USD denominated finance. When this flow slackens, the reversal will be based on fundamentals.
Isn’t it time for a bit of good old-fashioned Keynesianism? I read that much of the infrastructure in the US is in poor shape (?). If so, where better could the government invest than in road, bridge, rail and airport renovation and improvement?
Economists have long argued that infrastructure investment is a necessary investment in developing nations. For different reaons, I would argue that the US economy is in need of re-development.
Posted by: Derek Tunnicliffe | November 1st, 2008 at 10:22 am | Report this commentConan the Barbarian of California has argued the need for, and opportunities of, energy and transportation redevelopment for the 21st century.
Posted by: Anarchocynicalist | November 1st, 2008 at 2:20 pm | Report this commentWall Street has faster ways of making bigger bucks, but this appears to risk national bankruptcy, and forced asset sales - Arizona back to Mexico, Alaska to Russia, Louisiana to France, … ?
Given that the last hundred or so big government solutions to the economy haven’t really worked out that well, perhaps it is time to try less meddling in the economy to make it hum along better.
How about something as simple as dropping the ridiculous ethanol import tariff? Suspending community banking regulations for 5 years? Establishing 100 zones in the country free of maniacal healthcare regulation? Leasing out Amtrak for $1 per year to anyone foolish enough to take it on.
People may be spending less because they are saving more, which is not all bad.
JBP
Posted by: John Powers | November 1st, 2008 at 10:05 pm | Report this commentputting federal dollars toward the redevelopment of our country’s infrastructure makes infinately more sense than allowing banks to use the money to pay dividends and bonuses.
Posted by: gym-bob | November 2nd, 2008 at 4:47 am | Report this commentthe argument that talent and investors would abandon the weakened firms to support new or better capitalized endevors exposes exactly what should happen. competition, regulation,victory and failure are key elements to healthy capitalism. spending money to improve american standards of science and math education would seem wise when compared with alternatives such as regime change or creating thirty year old investment banker millionaires.
the finance based bubble economy is beyond the fed’s control because the bubble was inflated by the shadow banking system outside the purview of the fed. an economy spurred on by massive leverage and an equally unsustainable asset liability mismatch won’t be coaxed back to health by lower interest rates. deleveraging and recession are the castor oil the global economy must swallow. the policies of greenspan et al were most flawed in that they continually subverted the nature of the system- the creative destruction. if our solution is to largely apply the principles that precipitated the failure we are destined to repeat our failures with increasingly dire consequences. we have either lost faith in capitalism’s power to revitalize itself and produce sustained wealth or have allowed the conflicts of interest to infect our political/ economic system to the extent that capitalism may become non-functional. capitalism is not designed to perpetuate a monied class but to spur innovative growth. when we read minsky, kondratief and gordon we know the unstable truth of this powerful economic force, its cyclical nature and the need for evolution in social structures of capital accumulation to match the creative destruction so elequently described by schumpeter. change frightens power. the current bailout measures are mostly aimed at preserving the past. focus must shift to the future. paulson is bound by the past and loyalty to the titans of failure. bernanke tries to straddle past and present.together they have found creative ways to re-cycle solutions aimed to right the wrongs of a depression 80 years in the past. the question remains who will lead to the future and what form will that future take.
consumer confidence has tanked for all the obvious reasons. for a decade or more the american consumer/ laborer has supplemented purchasing power with leverage. adam smith recognized that one of the truest measures of an economy’s health rests with its laboring class and its ability to consume what it produces. the american consumer levered up and powered the export economies of asia. we over consumed and they over produced. when spending and leverage rise while wages stagnate consumption must eventually decline. delevering means contraction on a global scale. relevering and flooding the world with fiat currency will lead to more and greater failure. as adam smith wrote the entrepreneurs will hear the siren song of excess profits and respond to the opportunity to innovate and prosper. but not until the feds stop subsidizing failure and instead begins to promote innovation.
“Réinventer l’Amérique” was the headline on the front page of the Swiss newspaper “Le Temps” yesterday, which included 14 pages about the USA, inc. interviews and visits to San Pierre, Chicago, Indianapolis and Cleveland. There were plenty of photographs (dispossessed people living in tents in Camp Hope, CA, for example) as well.
But when I also read that Obama is planning to
spend bigtime on alternative energies (Big Oil had better sign up and invest or lose out) and clean cars (Detroit, too, had better sign up and invest or lose out) then he CAN change America, and the World as well (by setting an example that all will HAVE to follow). Alternative energy and clean cars MUST be an important part of any new fiscal package, otherwise the USA is going to be left behind Europe.
Germany’s fiscal package (between €30B and €60B, depending on agreement reached by the political parties) for rebooting its economy will include tax breaks (maybe no tax at all?) for clean cars and €1B for upgrading buildings nationwide (inc with alternative energy) and the cost of labour for doing so will be tax-deductible.
Probably German automakers will get a big fiscal package of aid, as car sales in Europe have dropped dramatically: I hope German pols see this downturn as the right time to insist that the government aid is to be used to push massive investment by German automakers in a new generation of clean cars.
Posted by: J.J. | November 2nd, 2008 at 9:51 am | Report this commentJ.J. “Alternative energy and clean cars”
Were the next Congress and the next Administration to enact a fiscal stimulus, there are any number of areas to which that can be applied.
In particular, retooling of automotive plants to produce dramatically more fuel-efficient cars, any and all kind of investment in energy sources aside from oil and gas, any kind of infrastructure project.
If Senator McCain is elected, nothing good will happen. If Senator Obama is elected, anything is possible, even the implementation of policies beneficial to USA citizens and other inhabitants of Earth.
If many standing Republican members of Congress are defeated, the Republican right-wing that has dominated policy-setting for 30 years will be finally cowed into submission and therefore not be able to set as its only goal foiling any attempts at reform by the Democrats.
Only two more days to go, thank go.
I missed the item about Governor Palin that you cite in a comment elsewhere regarding the fake phone-call. I heard brief mention of a fake call from someone faking a French accent while flicking through television channels, but did not know what it relates to until I read your other comment.
There is no chance whatsoever that Governor will be considered for a political office beyond the office she now occupies under the assumption that Senator Obama wins this election.
I know little about Alaskan politics, but assuming the defeat of Senator McCain, Governor Palin has to return to her job. She apparently has made enemies of most of the political class in Alaska, including of course the members of the dominant Republican party there.
What Alaskan voters think is ultimately what counts, but if Alaskan legislators are against her, I do not see how she can survive as Governor with any degree of effectiveness. She has shown herself to be a self-promoting primadonna, bereft of any sense of ethics or integrity, not to mention lacking knowledge or for that matter lacking the ability or interest to acquire knowledge outside of her very narrow range of personal and small-town political experience.
It appears that all the media attention and all the fawning crowds that she addresses have gone to her head, if she in fact made that comment to the fake caller. Her level of self-delusion and ignorance knows no bounds.
Posted by: Wendell Murray | November 2nd, 2008 at 10:43 am | Report this commentIf alternative fuel vehicles were such a good idea, all auto companies would have went that way long ago.
They are not good investments, and are just waiting to soak up more $$ while the auto companies was for their pensioners to die-off to reduce their costs.
Reading through the various stimulus packages, the only one that makes sense is John McCain’s corporate tax reduction. It should be implemented immediately rather than phased in, but it gets money in circulation rather quickly.
JBP
Posted by: John Powers | November 2nd, 2008 at 6:37 pm | Report this comment