The Star-Ledger (NJ), October 16, 2008
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As the outlines of a viable plan to rescue the global financial system begin to come into relief, it is time for policymakers to bring that same relief to Main Street.
The U.S. economy is already in recession, and American consumers are in no condition to nurse the economy back to health. The immediate need is for a fiscal stimulus to counteract the negative effects of the deflating housing bubble and the turmoil in financial markets on household and business spending.
Deficit hawks object to a fiscal stimulus because it will increase the deficit. But their commitment to budget balance is misplaced in the current circumstances. Economists agree that deficit spending is good for the economy when, as is happening today, a lack of demand by consumers and businesses causes the economy to operate below its potential. With people and resources unemployed, government spending will lead companies to produce more goods and services, create more jobs and hire more workers without creating bottlenecks in the economy.
In the present circumstances, deficit spending will neither drive up interest rates nor crowd out private investment. The economic slowdown and the seizing up of credit markets have for the moment constrained the desire and the ability of firms to undertake private investment. If anything, increased spending by the government will strengthen markets for the goods and services produced by businesses, raise cash flow and profitability, and stimulate investment.
Having lost the economic argument, deficit hawks have regrouped to argue that the $700 billion bailout of Wall Street ties the hands of policymakers and makes it unwise for Congress to enact a fiscal stimulus. It rules out help for Main Street and aspirations for prosperity and growth. This is a complete misreading of the effect of the bailout of financial markets on the economy.
The $700 billion bailout adds to the national debt but should not be considered part of the annual deficit. The government long ago made an implicit commitment to stand behind U.S. financial institutions through the "too big to fail" doctrine. Now it is honoring this commitment. As a result, the government is recognizing expenses that were actually incurred in 2005, 2006 and 2007 when the bad loans were made. This action provides no stimulus to the economy. Rather, its effect is to prevent financial wealth held by businesses, by banks, and in individual retirement accounts from disappearing. This raises the national debt but doesn't affect the annual budget except as an accounting entry.
The long-term effect of the Wall Street bailout on the national debt is likely to be substantially less than $700 billion, as the Treasury will ultimately recoup a substantial portion of this expenditure. The prospects for getting much of the money back are much greater now that the Treasury has agreed to use this authority to capitalize banks and financial institutions and to take an ownership stake in them rather than to simply buy up banks' toxic assets at inflated prices.
A fiscal stimulus of $300 billion to $400 billion -- about equal to the amount of spending wiped out by the decline in house prices -- will avert a deep downturn and put the economy back on the path to growth. The stimulus package should include temporary measures to boost consumption and to enable states and municipalities to maintain services such as extending unemployment benefits, temporary tax rebates to low-income households and block grants to states to support spending on Medicaid and child health programs, on education and training, and on social services.
Investments in infrastructure and in energy-conserving retrofitting of houses, businesses and government buildings would engage hard-hit construction firms and their employees while contributing to the long-term growth potential of the economy. Investments in literacy, education, and health care reform would increase the productivity of American workers and businesses.
Such a stimulus package meets the three basic rules of deficit spending. It increases government demand at a time when credit is scarce and household and business demand is faltering. Unlike tax cuts for the wealthy, it provides a high degree of stimulus for every dollar spent. And it spends money in ways that increase the nation's long-term growth potential.
Whether today's deficits increase the burden on future generations depends on how the borrowed money is spent. If it is spent to increase literacy and education levels or to build a modern physical and information infrastructure, then it will make future generations wealthier.
As the president warns of the danger of another Great Depression, it is well to remember that concerns over deficits prevented the Republican administration of that era from taking all necessary steps to stimulate the economy and restore growth. Surely this is a lesson we should all have learned and should never have to learn again.
Eileen Appelbaum is a member of the Advisory Board of Economics for the Center for Economic and Policy Research. She is a professor at Rutgers University in New Brunswick and Manchester Business School at the University of Manchester in England.