Expensive, Dangerous and Necessary
Over the past several weeks, two unpleasant realities have come into sharper focus.
The first, which has come in the form of public speeches and private warnings from top officials here in Washington, is that the government is going to have to commit a lot more money and become a lot more active in managing the economy if it is to prevent a financial and economic collapse.
The second is that there's only so much government policy can do.
That's the tough political sell for congressional leaders and the incoming Obama administration as they seek to win the country's backing for a big new economic stimulus bill and a second round of bailout money for the banking and financial system.
There is already a strong political backlash against the federal rescue of the big banks and the Detroit automakers -- from the left, which thinks it was nothing more than a Bush administration bailout for rich bankers who caused the crisis in the first place, and from the right, which sees it as the first step toward socialism. And now Americans are told that notwithstanding the enormous sums already committed by the Treasury and the Federal Reserve, it wasn't enough to "fix" the problem and that much more will be needed.
The dilemma was nicely summed up yesterday in a press release put out by the House Appropriations Committee outlining its plan -- a pretty good one, by the way -- for $550 billion in "investment" spending designed to stimulate the economy.
"The economy is in such trouble that, even with passage of this package, unemployment rates are expected to rise to between 8 and 9 percent this year," the committee said. "Without this package, we are warned that unemployment could explode to near 12 percent."
Great news! We're going to lose only another 2 million jobs! And it will cost the average American household only $6,000.
You see the problem.
It would be great if there were a simple way out of this political and economic conundrum, but there isn't.
The basic problem is that over the past several years, the U.S. economy over-expanded in response to a surge in debt-financed spending by American households and government. It all made sense as long as home prices and commercial real estate prices and stock prices and commodity prices were what the markets said they were and we could draw on that paper wealth to support a higher lifestyle. Unfortunately, it was all a mirage. Once the cheap credit disappeared and the asset values plummeted and consumers began to pull back on their spending, it suddenly became clear that we didn't have the income to support all those shops and restaurants, hotel rooms and airline seats, auto lines and steel plants and media outlets.
The current recession is the process by which a market economy adjusts to that reality, which in this case could involve shrinking capacity in many sectors by 10 percent or more. And while that adjustment will be brutal, it is necessary to get to the point where supply and demand get back into balance so that the economy can begin to grow again in a healthy and sustainable way. To try to stop that process and return things to the way they were would amount to nothing more than reinflating the bubble economy.
What government can do, however, is try to manage the process so that it doesn't spin out of control, as it probably would, and turn a recession into something deeper and longer. That's what the stimulus is about. By making public investments in projects -- rebuilding the energy grid, expanding public transit, catching up on years of deferred maintenance of roads and bridges, computerizing medical records -- government can provide short-term employment to some people who would otherwise be left unemployed as a result of the adjustment process. And if those projects are carefully selected, then they should be able to pay for themselves in the form of greater output, higher incomes and increased government tax revenue in the future.
What is the optimal level of stimulus? In truth, nobody really knows. Spending too little runs the risk of allowing a vicious cycle to begin that picks up so much momentum that the economy overshoots on the way down just as it did on the way up. Spending too much runs the risk of putting money into things that have only a modest impact on employment (individual and business tax cuts) or disappointing long-term payoffs (expensive highway projects that do little to alleviate congestion).
Given, however, that even before this latest initiative, the government was expected to run a deficit of about $750 billion, or 5 percent of gross domestic product, adding $750 billion on top of that looks like a pretty generous dose of fiscal stimulus. Going much beyond that -- to $1 trillion or more, as some commentators have suggested -- looks less like an effort to manage a necessary but painful reduction in our collective standard of living and more like an effort to revive the old bubble economy.