The Obama Plan: Overweight Fiscal?

By Simon Johnson

Most of the current discussion regarding the Obama Economic Plan focuses on whether the fiscal stimulus should be somewhat larger or smaller ($650-800bn seems the current range) and the composition between spending and tax cuts. President-elect Obama stressed on Tuesday that trillion-dollar deficits are here to stay for several years, and it looks like part of the arguing in the Senate will be about whether this is a good idea.

There is at least one key question currently missing from this debate. Is this Plan too much about a fiscal stimulus and too little about the other pieces that would help - and might even be essential - for a sustained recovery? The fiscal stimulus may be roughly the right size (and $100bn more or less is unlikely to make a critical difference), but perhaps we should also be looking for more detail on the following:

1. Recapitalizing banks. Their losses to date have not been replaced by new capital and it is currently not possible to issue new equity in the private markets. If you think we can get back to growth without fixing banks, check Japan’s record in the 1990s.

2. Directly addressing housing problems, including moving to limit foreclosures and reduce the forced sales that follow foreclosures. There is apparently some form of the Hubbard-Mayer proposal waiting in the wings, but we don’t know exactly what - and this matters, among other things, for thinking about the debt sustainability implications of the overall Plan.

3. Finding ways to push up inflation, presumably by being more aggressive with monetary policy. Deflation is looming - according to the financial markets, despite all of the Fed’s moves and recent statements, prices will fall or be flat over the next 3 to 5 years. This fall in inflation, from its previous expected level around 2 percent per year, constitutes a big transfer from borrowers/spenders to net lenders/savers. The contractionary effect is likely to outweigh any fiscal stimulus that is politically feasible or economically sound. (We have more detail on this point on WSJ.com today, linked here.)

So perhaps the issue is not the absolute size or composition of the fiscal stimulus, but rather the role of the fiscal stimulus relative to other parts of the Plan. Hopefully, it’s a more evenly weighted package, and just we haven’t yet seen the details. Still, it’s odd that the presence and general contours of these other important elements have not yet been clearly flagged.

Comments

[bosun.j:]

The Banksters have had their way with Obama. Obama is going to dramatically increase spending while concurrently cutting taxes.

Anyone in recent history you can think of who did this?

Hope? Change? This Obama guy is going to compound the mistakes of BushCo.

GET OUT WHILE YOU STILL CAN!!

Jan 07 10:03 AM

[Crocodilian:]

You can go to some trouble to look for "debate" on responses to the financial crisis . . . and not find much. From Hank Paulson's demarche to Congress "Give me $700 billion and ask me no questions" to the Federal Reserve's silence on just what assets its taken on and from whom, policy responses have essentially been diktats.

We should be looking for more detail on each of the points that you outline: but we probably aren't going to get it. Moreover, for the sake of argument, I'd at least throw out the hypothesis that the markets aren't really capable of digesting all the myriads of policies that might reasonably be discussed. That was one of the criticisms of the New Deal, that with so many financial initiatives underway, it becomes hard for businesses or investors to discern "the signal" because there are so many signals.

So they do what we're doing, and sit on their hands until the situation becomes less murky.

Jan 07 11:48 AM

[Moon Kil Woong:]

I don't see real change until the market can move up without some silly givaway party by the government. Real economic growth is driven by the private sector not the public sector. If a short term stimulus gets the private sector going again great, but I don't see it in 2009.

This has nothing to do with Obama. Any new President would try to dump money into the system because that's all they know how to do. That's exactly why the government is not running your business.

Real change will require getting confidence there are not more Citibanks, Madoffs, AIGs, Bear Stearns, Lehmans, etc out there. The longer we bail them out the longer it takes to insure the market these crooks are not still going to swindle everyone on the face of the earth starting with the US taxpayer.

Fix that and you go further in terms of fixing the recession than all the TARPs and stimulus plans you can dole out.

Jan 07 11:48 AM

[Socialism c...:]

Was this economic crisis planned?

www.worldnetdaily.com/...

Jan 07 12:07 PM

[John Lounsbury:]

Attempts to solve the crisis by attacking the housing price and construction readjustment appears to be too steep a hill to climb. (Article is coming.) Spending money in that way offers no future economic growth leverage. Money spent in that area should be no more than necessary to prevent collapse of the financial system. Stimulus should be focussed as much as possible on enabling future economic growth. Such things are infrastructure (energy, transportation) education and getting the health care inefficiency burdens off the backs of business.

I agree with the author that the "flat period" in the economy could well be three years or more. That is the period I see for the housing market to bottom - there is a 2 1/2 year inventory overhang (current inventory plus forthcoming foreclosures) that can not be broken by any rational plan of stimulus support. On top of that, demographics will permanently depress home building for the next 15 years, at least.

The days of getting rich by building houses and selling them to each are over.

Simon, I don't agree that the housing problem can be fixed, only cushioned. This needs to be done in such a way that better use of tax payer dollars can be accomplished.

Jan 08 12:03 AM

[Steven Hansen:]

John,

the housing crisis cannot be fixed but they will spend the money anyway. miss-spent money does not stimulate the economy. we are digging a bigger and bigger hole.

i do not understand when the basic economic recovery scheme did not work in previous recessions, the conclusion was drawn that not enough money was thrown at the problem. it surely could not have been true that that the concept itself was flawed as it would have undercut existing economic dogma.

in any event, we will recover at some point from this mess wiser and dumber - and continue to draw the wrong conclusions from historical events.

Jan 08 02:07 AM