Recession Solution: Balancing Trade

by: Howard Richman

Martin Feldstein is the most highly esteemed Republican Party economist in America today. His analyzes are clear and understandable. In a recent commentary he breaks with other Republicans and urges passage of a large stimulus plan, similar to the one proposed by President Obama. He attributes America's short-term problems to a $600 billion fall in demand for U.S. products:

The 40% decline in the U.S. stock market and the dramatic fall in house prices have reduced American households’ wealth by more than $10 trillion, which is likely to reduce annual consumer spending by more than $400 billion. And the collapse of housing starts has lowered construction spending by another $200 billion. This $600 billion fall in demand is more than 3% of GDP. If not reversed, it will cause further cuts in production, employment, and earnings, leading to further reductions in consumer spending.

He then points out that the Federal Reserve cannot solve the recession by lowering interest rates:

The usual monetary-policy response of lowering interest rates is unable to reverse this sharp drop in demand. The dysfunctional credit markets caused by the uncertain value of asset-backed securities means that banks and other financial institutions are unable to raise funds and are unwilling to lend. As a result, the central bank’s lower interest rates do not translate into increased spending on interest-sensitive investment and consumption.

Then he shows a blind spot. He concludes that the only alternative is fiscal policy (i.e., larger government budget deficits):

So there is no alternative to fiscal policy if we want to reverse the current downturn....

Feldstein is missing the third alternative: solving the trade deficit. If the recession is indeed caused by a loss of $600 billion of demand, as he argues, then eliminating the $665 billion U.S. trade deficit through Import Certificates would completely solve it. In other words, there would be plenty of demand for American products if foreigners purchased as much from us as we purchase from them.

Martin Feldstein's calculations show that the stimulus package would be entirely unnecessary if we solve our trade deficit. Instead of racking up more and more government debt and more and more foreign debt, we can get out of the recession by balancing trade.