Keynes argued that what is needed to reverse this
is an increase in government spending – a stimulus package of spending
increases, tax cuts, and deficits that would initiate a spending
effect throughout the economy.
Government could even build bridges to nowhere, although
somewhere would be better.
bridges would be better than one, and one would be better than no
When workers are paid for building the bridge(s), they will buy
and services in the private sector of capitalism; and it would begin to
Businesses will begin to prosper
more workers, who will in turn spend more money, etc.
President-elect Barack Obama has announced that he will propose a
stimulus package, perhaps in the vicinity of $500 - $750 billion.
Many economists have argued that when private
spending is falling dramatically, then more government spending is
needed to fill the void –
sooner, the better -- to avoid a second Great Depression.
It could perhaps be on a scale of World War
II military spending beginning in 1942, which brought the unemployment
the U.S. down from double digit to less than 2% in 1944.
One of the reasons that the Great Depression
lasted so long is that the government was timid about deficit spending.
However, during WWII the U.S. federal
government ran enormous deficits for the war, which not coincidentally
pulled the economy
out of the depression.
In 1929 total government purchases of public goods
and services in the U.S. was $9.4 billion.
The public debt was 16.3% of GDP.
By 1939 government purchases had only increased to 14.8 billion
annually, the debt was 52.2% of GDP primarily due to falling tax
tax cuts), and the unemployment rate lingered around 20%.
In 1942 government purchases jumped to $62.7
billion and the unemployment rate fell to 4.7% in that same year.
By 1946 the national debt was 122% of GDP
and the economy was running on all cylinders].
reason that the 2009 stimulus package has to be so large
is that the problem is rapidly becoming more serious. The stimulus
proportional the GDP gap, which is the difference between the actual
the GDP at full employment.
we go into recession, the larger the stimulus package needs to be.
Unfortunately, we have not yet begun to see
just how bad the U.S and the other economies can get.
And the longer we wait to do something, the worse it will get
before it gets better.
It should come
as no surprise to anyone when the unemployment rate in the U.S. reaches
higher next year.
cannot depend on monetary policy and financial bailouts
to solve the immediate problem.
federal funds rate in the U.S. is already close to zero.
Interest rates can’t get much lower, and
lower interest rates are unlikely to stimulate the economy to any great
If the economy falls into a
liquidity trap, then monetary policy simply won’t work.
Troubled banks have a hard time lending to
Monetary policy is
notoriously impotent when it comes to stimulating an economy, and its
lag times are very long.
The deeper the
recession, the weaker monetary policy becomes.
Although low interest rates and bank liquidity and solvency may
necessary conditions for recovery, they are not sufficient.
Figure below shows the playing field of The Global
It indicates that the
United States, the United Kingdom, Japan, and the Euro area countries
already in a recession and heading toward a depression in the lower
left hand corner of the
field. The Economic Indicator points
in the direction of the current trend in 2008.
[Note: As an economy
moves from left to right on the playing field it grows faster. As it
it gets more inflation; as it moves down it gets disinflation and
Black numbers in the playing field indicate a positive score. Red numbers indicate a negative score. The further into a corner an economy goes,
the worse its macroeconomic performance and the lower its score. The best score is in the very center where
there is full employment and other macroeconomic goals are in balance].
Figure also shows that the most direct counter-cyclical
policy tools to get out of or to avoid a recession are:
1. Increase the Money Supply and, thereby,
lower interest rates to indirectly stimulate consumer and business
2. Increase Government
Spending for public
goods and services like infrastructure that will directly create new
Depreciate the Currency, which stimulates exports and curtails imports.
already noted that monetary policy may not be powerful
enough to keep an economy out of or to get it out of a recession or
And the problem with
depreciating a nation’s currency is that it exports the recession to
country, which in turn, will want to depreciate its currency to avoid
Two countries can’t
depreciate their currencies simultaneously.
That leaves fiscal policy as the best and most effective policy
especially if all countries cooperate.
If all of the countries were to initiate stimulus packages
then they could change the economic indicator away from recession and
full employment at the center of the playing field.
What the Critics Will Say
What about driving up the national debt?
that bad? The U.S. national is debt nearly
$10 trillion, which is about 70%
of its GDP. A major stimulus package
would increase the national debt/GDP ratio, because the debt would
grow faster than the GDP. It is a
legitimate question to ask whether this would be good or bad.
is probably no other topic in economics that is less
understood and more misunderstood than the national debts of nations.
People tend to draw comparisons between
their own ability to manage debt and the government’s ability.
The comparisons break down under close
The common denominator is
basic economic reasoning:
marginal benefit of the debt is equal to or exceeds the marginal cost,
debt is worthwhile.
If, on the other
hand, the benefits are less than the costs, then it’s not worthwhile.
a son or daughter to college on borrowed money is
worthwhile if they study and become successful.
is a mistake if they don’t study, flunk out and remain a low
productivity worker or chronically unemployed.
The same is true of governments.
It makes sense to incur debt and spend money to defend freedom
avoid a depression if the alternatives are to lose freedom or to live
of those who will criticize President-elect Obama’s
stimulus package on the grounds that we can’t afford a higher national
What we can’t afford is a
Also, beware of the protectionists.
They tend to become more vocal during hard times.
They will argue that we should protect
American jobs at the expense of foreign jobs.
The problem with that argument is twofold:
we don’t buy imports, then foreigners can’t buy our exports;
and there’s nothing preventing other countries from protecting their
jobs from our export competing products.
Everybody loses in a trade war.
That was one of the most significant lessons of the Great
common ideological argument against deficit spending
on the part of the government is that it crowds out the private sector.
Pretty soon, the argument goes on, there is
no private sector – only a public sector.
Everyone will become dependant on the government for his or her
well-being from health care to education to employment.
While this argument may have merit in the
long run, it doesn’t do anything for us in the short run.
Right now, capitalism’s private sectors are
They are the problem, not
is one caveat we should proffer regarding a
contemporary deficit spending stimulus package for the United States.
Historically, the U.S. government has
deficit spent and run up the national debt when it was able to manage
rapid economic growth in its future.
After WWII, for example, the U.S. economy grew more rapidly than
debt and the debt/GDP ratio fell precipitously to 33% by 1980.
This time it won’t be as easy for the U.S.
economy to recover so rapidly.
because it faces much more competition from other countries around the
unlike the post WWII experience where it was competing with war torn
Increasing productivity in the
U.S. relative to other countries is problematic.
that might make the rising debt more difficult to manage, it
is not a strong enough argument to nullify the efficacy of the stimulus
that we need next year.