It really was the end of the world.
It's hard to remember now, but in 2008 Lehman's collapse seemed like the start of something worse than a second Great Depression. As Barry Eichengreen and Kevin O'Rourke point out, world trade, world stock markets, and world industrial production all fell faster in 2008 than in 1929. It was just about the biggest economic shock in recorded history, and the abyss beckoned.
But we avoided it. We "only" got a Great Recession, and not the Greater Depression. That's clear enough in the charts above (and in the fact that we still have something called "an economy," and aren't all farmers today). As you can see, the 2008 crash started out worse than the 1929 one, but soon stabilized and then started to recover. That's because, despite the quicker collapse, policymakers today didn't make all of the mistakes of the 1930s. Instead of raising rates and trying to balance budgets as the bottom fell out, they did the opposite—at least initially. In early 2009 China launched a relatively massive $585 billion infrastructure program. The Fed started printing money and buying bonds à l'outrance. And then there was the stimulus.
It's become a political four-letter word, but the reality is that the $787 billion stimulus was too small for the job, and even smaller than it sounded. A full $70 billion of it didn't go to new programs, but rather to fixing the Alternative Minimum Tax. That left far too little money to fill the economy's hole—a hole that was far deeper than we realized at the time. Indeed, when the administration said the Recovery Act would keep unemployment below 8 percent, it thought GDP was falling 3.8 percent; subsequent revisions showed it was actually falling 8.9 percent.
But even if so much of the stimulus hadn't gone to non-stimulus, and even if we'd known exactly how bad the economy was, there was one last problem. The administration assumed this time wasn't different. That the economy would bounce back on its own—and soon. But it didn't, and they should have known that it wouldn't. Financial crisis recoveries tend to be nasty, brutish, and long. The shock of seeing the world as we know it almost melt away scares people into not spending—if they can even afford to spend. Many couldn't, because household debt was so high. In other words, the stimulus wasn't about kickstarting a recovery that wasn't coming. It was about preventing a depression that was.
So I come not to bury the stimulus, but to praise it. Yes, it should have been bigger. And yes, it was oversold. But it helped put a floor under the economy when there was none, and people still miss that. They miss it, because the stimulus was designed to be missed. There were tax cuts people didn't notice, because they got them each pay check instead of as a lump sum. There was aid to state and local governments that people didn't notice, because you don't see the layoffs that would have happened but didn't. And then there were the moonshots that people didn't notice. An education reform—Race to the Top—that offered prize money to schools that adopted tougher standards, performance-based evaluations, and lifted caps on charters. A clean energy revolution that, despite a few misses, has, as Mike Grunwald points outs, increased wind energy by 145 percent and solar panel installations by 1,200 percent. And money to get hospitals to shift from paper to electronic records.
But maybe the best argument for the stimulus is that there were no good ones against it. Here, briefly, were those not-so-good arguments, and why they're wrong.
1. Stimulus doesn't work, because "the money has to come from somewhere," and that somewhere is the private sector—so public spending necessarily crowds out private investment. This is a freshman-level error, a fallacy resurrected from the 1930s. It's wrong, because the private sector doesn't always want to spend the money it saves. Because interest rates can't always fall, if they're already at zero, to make the private sector want to save less and spend more. In that case, GDP will fall instead to bring savings and investment into balance—unless the government borrows the money the private sector won't.
2. Stimulus doesn't work, because higher deficits today will make people anticipate higher taxes tomorrow—so they'll cut their spending now. Let's set aside the fact that most people don't even know whether the deficit is rising or falling, let alone what means for their future taxes. Or that even if they did have perfect foresight, they probably couldn't afford to save much more today if they knew taxes were going up tomorrow, not when almost half of Americans live paycheck-to-paycheck. No, let's grant these ridiculous assumptions. It's still not an argument against stimulus.
As Paul Krugman points out, a temporary stimulus gives us money up front that we don't have to pay back all at once. We pay it back over the life of the loan—and the longer the loan, the less we have to pay back in any one year. So any future tax hikes will be much smaller than the stimulus itself—and people will cut their spending today much less than it.
3. Stimulus doesn't work, because the Fed will either tighten money to offset it, or won't ease money like it otherwise would have. There's something to this, but it still falls short. The proof is in the slump. If the Fed were going to make stimulus unnecessary, it would have made stimulus unnecessary. There wouldn't have been a Great Recession, and there would have been a faster recovery. Now, the Fed has gotten better lately, helping to offset last year's austerity with easier money, but the reality is that it's more cautious when interest rates are zero, and still doesn't do enough.
The Fed knows this. Its forward guidance has actually been a way of begging Congress to do more stimulus by telling them how much it will allow. Indeed, Ben Bernanke made this more explicit last December when he blamed the slow recovery, in part, on "very tight fiscal policy." Translation: Hey Congress, stop it with the austerity already and try spending some more!
There are no atheists in a foxhole, and there shouldn't be any austerians in a depression. When the economy is collapsing like it never has before, you throw everything at the problem, monetary and fiscal stimulus.
The Recovery Act could have been better, but our world would have been much worse without it.
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