Why the Federal Stimulus?

Martin Feldstein and Paul Krugman have teamed up, calling for increased government programs and more policy proposals to help avert a new nadir in the recent economic crisis. The former’s recent column in the Washington Post claims:

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. Another round of one-time tax rebates won’t do the job. The rebates that Congress enacted this spring failed to stimulate consumer spending: More than 80% of tax rebate dollars were saved or used to pay down existing debt. The only way to prevent a deepening recession will be a temporary program of increased government spending.

As much as Feldstein thinks that tax rebates did little to stimulate consumer spending, he seems to be in a camp of his own. Parker’s findings indicate that household spending increased when consumers received their stimulus payments. Parker’s report goes on to say:

With the Economic Stimulus Act of 2008, policymakers tried to increase disposable income temporarily through tax rebates in the hopes that households would increase or maintain their spending levels and so end or at least mitigate the severity of a U.S. economic slowdown. We find some success: the stimulus payments are initially being spent at significant times.

Feldstein, it seems, does have one other bedfellow. Paul Krugman’s most recent “work” reads:

Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. 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…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 earlier 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.

Although Krugman and Feldstein may disagree with me, consumers should cut their spending now. Everyone knows that consumers have been living beyond their means. If, hypothetically, consumers decide to maintain their spending (whether through a cut in sales tax or a Krugman-esque fiscal stimulus), but everyone knows consumer spending will decline in 18 months. While the so-called “liquidity trap” will be finished by then, investment commitments will be mediocre in the meantime, since people will be waiting for the economy to process change. Perhaps we need to spend less now and get the adjustment over with faster, even though that will be painful. Or say we don’t know when the spending decline will come—markets dislike uncertainty most of all.

I view the goal as expediting necessary sectoral adjustments and minimizing unnecessary (i.e., temporary) ones. Any of Krugman’s “stimulus” funds should go to preserving expenditure patterns of state and local governments. This ensures that the money is spent, if that is indeed the goal. Greg Mankiw offers a related solution. Indeed, the columns of Krugman and Feldstein are stark commentaries on how much of a fiscal “quick-fix” society we have become.

Krugman Wins Nobel

Many of you know Paul Krugman for his factually inaccurate and acerbic Op-Ed in the NY Times. Well, my friends, guess who won the Nobel in Economics? You betcha (wink)--Paul Krugman. His work in labor markets, my friends, garnered him the award, research that really was quite groundbreaking, even to the average hockey mom and Joe Sixpack. If not for his twice weekly column, many journalists believe he would have won the Prize several years ago. Darn right he is intelligent, but perhaps his idelogy rears its head too often for him to be taken seriously. Perhaps the Nobel will change that, my friends.

Krugman Actually Agrees With Me on the Housing Crisis (read: Switch to Gold Standard and Stop the Fed from Devaluing the Dollar)

Paul Krugman's Op-Ed article today supports what I have been saying about the problems of the dollar and the paradigm of housing:

Most of the bad investments now shaking the financial world seem to have been made in the final frenzy of the housing bubble, or even after the bubble began to deflate.

In fact, according to Fortune, Merrill Lynch made its biggest purchases of bad debt in the first half of this year — after the subprime crisis had already become public knowledge.

Now the bill is coming due, and almost everyone — that is, almost everyone except the people responsible — is having to pay.

The losses suffered by shareholders in Merrill, Citigroup, Bear Stearns and so on are the least of it. Far more important in human terms are the hundreds of thousands if not millions of American families lured into mortgage deals they didn’t understand, who now face sharp increases in their payments — and, in many cases, the loss of their houses — as their interest rates reset.

And then there’s the collateral damage to the economy.

You still hear occasional claims that the subprime fiasco is no big deal. Even though the numbers keep getting bigger — some observers are now talking about $400 billion in losses — these losses are small compared with the total value of financial assets.

Click here for the rest of Krugman's surprisingly correct article.

Disagreeing with Paul Krugman

Krugman recently asserted that there was no conceivable way that a lower government deficit could lead to a stronger dollar and a lower trade deficit without causing a recession. But there is a fairly straightforward way this could happen...

China is basically using our Treasury notes as a bank for future consumption, and, like all banks, it could fail by a series of poor business decisions. Under the Bush administration, the "bank" has been making such decisions, and China has, therefore, recently entertained ideas of diversifying. This contributes to widespread consternation (among other countries) and confidence in the "bank" declines.

We can solve this problem, therefore, by making better business decisions. One way to do so is to address budget deficits, real and imagined (the imagined are various entitlement shortfalls), so other countries will regain confidence in the bank.

While this does not solve the problem directly, it gives America time to get some fundamentals in place- namely, handling the savings rate. The rate plunged for two reasons: first, the Fed flooded the country with money, which made housing artificially cheap and led to a speculative bubble. This made people feel rich and they increased their consumption accordingly. This is why our economy is still growing at a decent rate even though real income is down. Second, income amongst nearly all Americans has declined due to the tax and regulatory policies of the Bush administration, so maxing out on home loans was necessary to maintain the standard of living. A change in tax policies, which would provide money to middle class Americans, combined with the current readjustment in the true cost of money, should allow for an eventual increase in the value of the dollar while simultaneously avoiding a recession.