by hilzoy
It's not every day that Paul Krugman and Martin Feldstein (head of Reagan's Council of Economic Advisors and an economic advisor to the McCain campaign) find themselves in complete agreement, but they are in agreement now. Feldstein:
"With the Fed's benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand. (...)The only way to prevent a deepening recession will be a temporary program of increased government spending. Previous attempts to use government spending to stimulate an economic recovery, particularly spending on infrastructure, have not been successful because of long legislative lags that delayed the spending until a recovery was well underway. But while past recessions lasted an average of only about 12 months, this downturn is likely to last much longer, providing the scope for successful countercyclical spending."
"One of the high points of the semester, if you're a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone’s income.In fact, consumers' income may actually fall more than their spending, so that their attempt to save more backfires -- a possibility known as the paradox of thrift.
At this point, however, the instructor hastens to explain that virtue isn't really vice: in practice, if consumers were to cut back, the Fed would respond by slashing interest rates, which would help the economy avoid recession and lead to a rise in investment. So virtue is virtue after all, unless for some reason the Fed can't offset the fall in consumer spending.
I’ll bet you can guess what’s coming next.
For the fact is that we are in a liquidity trap right now: Fed policy has lost most of its traction. It’s true that Ben Bernanke hasn’t yet reduced interest rates all the way to zero, as the Japanese did in the 1990s. But it's hard to believe that cutting the federal funds rate from 1 percent to nothing would have much positive effect on the economy. In particular, the financial crisis has made Fed policy largely irrelevant for much of the private sector: The Fed has been steadily cutting away, yet mortgage rates and the interest rates many businesses pay are higher than they were early this year.
The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response. (...)
No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend."
Likewise: Larry Summers, Ben Bernanke, Joseph Stiglitz (pdf), Nouriel Roubini, etc.
Here's a handy chart detailing which measures give us the most stimulus bang for the buck (h/t):
Good points. I think Kevin Drum also published that chart recently. I hope that help comes in time to the many needy people out there.
I don't expect much from this administration though.
Posted by: frank | October 31, 2008 at 03:48 PM
It was a little depressing watching/listening to the Joint Economic Committee hearing yesterday with Roubini and Simon Johnson (MIT/Sloan) and see them so direct and sensible, but very few Dems even there (Schumer in particular) and have to listen and relisten to the slow and patient explanations as to why corporate/private/personel segments are and will be tapped out and how a targeted spending program by gov is the only thing that will keep things from really tanking - all while the Republicans spun out nonsense like "uh, deflation is a good thing cuz stuff will cost us rich guys less" without ever seeming to process the recession issues and the size and magnitiude of those issues. Johnson and Dr. Doom were both so very worth listening too. It's too bad we don't hear enough of that kind of discourse.
Posted by: Mary | October 31, 2008 at 04:11 PM
If the temporary payroll tax holiday increased GDP by more than the tax revenue loss, then Obama's payroll tax expansion will presumably decrease GDP more than the revenue gain (tho not necessarily by the same ratio). That may be a worthwhile trade-off for improved funding of entitlements -- but perhaps not this year.
Posted by: The Crafty Trilobite | October 31, 2008 at 06:36 PM