Sunday, January 11, 2009

The Stimulus Package

Will massive government spending on "green" projects and infrastructure pull us out of our, so far mild, economic slump? Simple Keynesian theory drilled into the heads of countless Economics 101 students worldwide says "yes," but common sense suggests otherwise. Not that the US economy won't recover. It will. And that process should be well underway long before the so-called stimulus ever really gets started.

The bulk of the proposed stimulus would not be spent until 2010 or 2011, long after economic recovery has begun. The only thing that the stimulus package will do is create distortions in the economy (and possibly provide for the largest incentive for corruption in politics in the nation's history). (We will be looking for places to store unused wind turbines and inefficient solar panels for the next few decades.) The cut in the payroll tax, if it survives, does not have these drawbacks, but it looks like Congress isn't interested in cutting the payroll tax as much as getting their hands on increased spending for their favorite pet projects.

The reason the simple Keynesian paradigm is fallacious is that the simple Keynesian model is a timeless story. When you increase spending in that simple model (or cut taxes), the effect is instantaneous. Hence the result is stimulative at exactly the right time. In the real world spending and tax plans take time to implement, even after accounting for the delay in realizing that you actually need to do something. (Remember it was in December of 2008 that the NBER officially declared that the "recession" had begun in December of 2007). So, you end up with a one year lag in recognition, then a one year lag in implementation -- not quite instantaneous like the simple world of Economics 101.

{If you want to believe that the stimulus is a great idea, but just not grandiose enough, then check out Paul Krugman's articles in the NY Times. He thinks $ 1 trillion just isn't near enough!!! And he just won the Nobel Prize in Economics!}

So what will happen except a lot of wasted taxpayer money? By the time the spending hits, the economy will be recovering and plagued with a dramatically declining dollar and growing inflation. Both of these trends can be helpful. The declining dollar boost exports and the decline in the dollar and increase in inflation reduces the real value of our humongous national debt. (The escalating tbill and tbond rates will offset this rosy scenario for treasury debt financing). But, then what? With Paul Volcker on board, presumably Obama could recruit him to, once again, break the back of inflation. It would be the 30th anniversary of the date he took on this task at the request of Jimmy Carter, back in 1979.

When the smoke clears, most Americans will probably begin to start saving as their trust in government programs is gradually undermined by what they see going on with social security, medicare, medicaid, and whatever bureaucratic nightmare becomes the new "health care solution" imposed by an overwhelmingly Democratic Congress.

The good news is that Americans need to save more and trust their government less anyway. Government is really not able to do what it says it will do. If squirrels need acorns in the winter, some of the squirrels must gather and save the acorns. There are no squirrels doing this now, so there are no acorns set aside for winter. That will change as people realize they must save and protect themselves against the vagaries of their government.

There is reason for optimism, though. Obama seems much more sensible than his former compatriots in the US Senate. Larry Summers, his Treasury Secretary designate, was roughed up last week in a meeting with a group of prominent Democratic Senators. That's good news not bad news. It shows Obama is prepared to do battle with some of the crazies in his own party. Clinton had to do much the same. Who knows -- maybe Obama actually likes free trade (contrary to his campaign comments)? Hope springs eternal!

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