I’m not an economist, I’m not even kind of an economist. But there are a lot of other people out there who are not economists who have a lot to say about the economic stimulus, and some of what they’re saying leads me to some questions. Oh how I wish I could demand that a real economist answer them.
People are saying that Obama’s stimulus plan is too small. For example, here’s John Judis:
There’s much to like in Obama’s plan. But there are two important ways he may have to go further. Most economists agree that what finally pulled the U.S. out of the Great Depression was military spending for World War II. Some liberals argue that if the Roosevelt administration had not abandoned a Keynesian stimulus strategy in 1937-38, the U.S. might have gotten out of the depression without a war. But in 1936, unemployment was still at 16.9 percent; by 1942, after two years of war spending, it was 4.7 percent, strongly indicating that it was war spending that did it. I am not suggesting that the United States start a world war in order to solve the world’s economic problem. But I am suggesting a strategy that could be called the fiscal equivalent of war.
So let’s talk about fiscal stimulus a little bit. For at least the past decade, the US (and world) economy has grown due to one factor — the rise in housing prices. As housing prices went up, people borrowed against the value of their homes and spent the proceeds. That took the place of real income growth. As we now know, the rise in housing prices was not sustainable. Prices stopped rising, people lost the ability to borrow, and now the economy has essentially shrunk down to its pre-bubble size.
I don’t know how to mathematically model any of this, so let me use an analogy. Before the housing bubble burst, the economy was a size XL shirt. Now it’s size L shirt. The economy is rapidly losing weight so that it can fit into the size L shirt. What this means is closed down factories, canceled construction projects, and massive job loss.
The purpose of fiscal stimulus is to stretch the shirt back out to size XL. This works by replacing consumer borrowing (by way of home equity loans, cash-out refinances, and credit cards) with government borrowing. The idea is that the government will stretch the shirt until the economy grows enough for the shirt to remain size XL without fiscal stimulus.
So that leaves me with two questions about the stimulus plan in particular. One, is the government able to stretch the shirt as much as it needs to, and two, for how long will it be required to stretch the shirt? There’s some level of government borrowing that is not sustainable. And there’s some level of borrowing that can be managed for a year or two but not longer.
And my bigger question is this: what if the size L economy is the new normal, and the only thing that will save us in the end is population growth? What then is the proper course of action for the government? If the current crisis is a product of structural change, what’s the best recourse? Replacing consumer borrowing with government borrowing isn’t going to save us if there’s no path back to the size XL economy anytime soon.
Update: I am very glad this guy is our next President.