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.)
Thanks, Clive. I feel so much better now.
"If European governments and other countries introduce big fiscal plans of their own (as they should, in their own interests), the chances of a flight from the dollar would come down. Second, the package should ideally include commitments -- including postdated tax increases and reform of the budget process -- that would reassure investors that Washington will bring the deficit back under control once the crisis is over."
But this:
http://stumblingandmumbling.typepad.com/stumbling_and_mumbling/2008/10/the-benefit-of-inequality.html?cid=137119795#comments
"Stumbling and Mumbling on a stimulus plan:
"This raises an obvious question. If government borrowing today merely means lower state spending or higher taxes tomorrow, why should it boost aggregate economic activity at all? Won’t it just cause tax-payers to save in anticipation of higher future taxes, or public sector workers to save in anticipation of redundancy?
This is, of course, the challenge of the Ricardian equivalence hypothesis. This says that fiscal policy is impotent, because people should save in anticipation of higher future taxes, which is what borrowing is."
Will people save in preparation of tax increases? Or losing a job?
"the UK is one of the few countries in which Ricardian equivalence is wrong. So perhaps fiscal policy might work.
How can this be?
It‘s not necessarily because people are short-sighted. It‘s because they are liquidity-constrained - they can’t save or borrow enough.
Put yourself in the shoes of a poorly-paid person. You might anticipate higher taxes in five years’ time. But what can you do about it? You’re struggling to pay rent and leccy bills today. You just can’t save as a precaution against future problems - you’ve enough on your plate making ends meet now."
Well, if people are poor enough, No. They can't. They need to live.
"But what if we had a more progressive tax system, with taxes only levied upon those of us who can afford to save? We might well trim spending on fripperies to save more. We would then be in the world of Ricardian equivalence, in which public borrowing was offset by private saving."
So, people who can save will.
Conclusion:
"My point is simple. What allows Darling’s fiscal policy to work is the fact that taxes fall upon people who can‘t save. If the poor were better off - and so able to save - or if taxes were more progressive, fiscal policy would be less powerful.
Personally, I’d prefer a world of greater equality and less powerful fiscal policy. But not everyone shares my preference."
I agree, but I'm not sure I accept the reasoning. For one thing, oddly, if the rich will save in anticipation of future taxes, why not tax them now, and obviate that problem. Another possibility would be to raise taxes until they don't want to save. One could also tax their savings. I'm not advocating any of these things, but there do seem possibilities to counter this effect where it exists."
And this:
"You might be interested in this about the Japanese stimulus plan from the FT:
http://www.ft.com/cms/s/0/00df00ae-a63c-11dd-9d26-000077b07658.html
"Although the handouts would increase household disposable income, given that there could be a consumption tax rise in three years, the plan was structured in a way that would encourage people to save, Mr Morita said."
Now, are we more like Britain or Japan? Easy, where saving is concerned. But you've already mentioned the tax cuts earlier this year, and the fact that a lot of it was saved. Now this, from the WSJ:
http://blogs.wsj.com/economics/2008/10/31/good-news-for-stability-bad-news-for-growth/
"Part of the reason that consumer cut back on spending in September is that Americans were putting more of their money into savings. That may not be good news for GDP growth in the short-term, but it’s a positive sign for the long-term stability of the economy.
In September, personal saving — disposable personal income less spending — was $140.3 billion, compared with $82.5 billion in August. That raised the savings rate to 1.3% from 0.8% in the previous month. The savings rate spiked from May to July on the back of the government’s stimulus payments, but averaged below 1% for a number of years. It was just 0.2% in April before the stimulus payments went out, and has been nearly flat for years, not rising more than 1.5% in any month since 2004. The rate was in double digits in the 1970s and early 80s, but began a steady decline to the historic lows reached in recent years."
So, I'm with you on the stimulus, and we should eventually work on the deficit and debt, but, for God's sake, don't announce that now.
As the WSJ reports:
http://blogs.wsj.com/economics/2008/10/31/ecb-to-governments-spend-more/
"In a currency bloc governed by strict rules about how much debt national governments are supposed to hold, it doesn’t happen often that a central banker encourages governments to up spending. But radical times call for radical measures."
Let's be radical now, and conservative later.
If they give a stimulus, I promise I will spend it and not save it. Honest. I need some repairs on my car and a HD TV antenna. Mundane, yes, but necessary. Plus a nice Xmas present for my parents (who are in their 80s). And perhaps some chew toys for my little chihuahuas "Roma" and "Flower."
So you don't think a spending freeze (a la McCain) would really be such a good idea, hmm?
Clive,
You make this point about the benefit of aid to states for infrastructure spending,
And then also note the need to reassure the bond market that federal deficits will eventually be reeled back in,
Here is an idea that may accomplish both goals: instead of simply writing a check to the states, the federal government ought to offer to buy an equivalent amount of new general obligation bonds issued by the states. These bonds could be structured with low coupon rates for the first few years, say, 1% above the rate on the U.S. Treasury bonds, with a reset to higher rates after three years. That ought to give the states the funds to cover their budgets and complete infrastructure projects, and give them an incentive to refinance the debt by issuing new bonds to the usual municipal bond investors after the downturn ends (with taxes likely higher in a few years, there would be more demand from affluent investors for tax-free municipal bonds). Knowing that the federal government would be repaid in a few years ought to assuage the market for U.S. Treasuries.
People this past year have had to tighten their belts to make up for the exorbitant cost of fuel.The high cost of fuel in turn raised the prices of every consumer product from farming &shipping food, to producing and shipping other products.Electric companies passed on their higher production costs with large rate increases. We have spent less because we had less to spend.Many have quit eating out as much or at all, quit going to the movies, quit buying new products and only stuck to the bare necessities.Now it is being an increase has been reported of people have had to stop taking necessary medications because they can't afford them anymore.That has sadly resulted in even more job losses. We spent 168 Billion on the last stimulas pkg.that did zip for our economy. That could have gone a long way toward getting us started on the road to energy independence!! Why doesn't our country invest in getting us out of this mess instead of their quick fixes that don't work? I just read a facinating book The Manhattan Project of 2009 by Jeff Wilson. Congress needs to read this book as well!
But this isn't free-market capitalism, it's socialism. It's bailing out companies that failed to understand its customers couldn't keep on spending when their health care premiums, college loans, mortgages, tuition, food, gas, heat, clothing, car payments, day-care costs, auto insurance, credit-card payments, and the co-pay on their prescription for antidepressants exceeds the two or three minimum-wage service-sector jobs.
Total failure of the market to understand its customer base.