The case for fiscal stimulus

In this article for National Journal, I look at the arguments for a second fiscal stimulus. In light of the most recent data another fiscal boost is needed, and it had better be big.

This week, we learned that consumer confidence crashed in October to its lowest level since records began more than 40 years ago. This is far more worrying than a run of bad days on Wall Street. So severe a collapse in confidence -- forecasters had expected a big drop, but not this big -- is invariably the leading edge of a major recession, and unless governments act promptly and wisely, maybe a very prolonged one as well.

Several interacting forces are pressing the economy down. First, the credit system is broken. Good corporate borrowers cannot get financing to make new investments, or in some cases even to cover their payrolls and stay in business. Households are finding it harder to get loans as well, which is holding back recovery in the housing market. The government's $700 billion bailout was intended to preserve the flow of loans. Without it, things would be even worse, but the situation is still anything but normal. The Treasury Department is telling banks that they must lend, lend, lend; but they are weak, and a process of sudden "deleveraging" -- a collectively self-defeating effort to avoid risk by curbing credit -- cannot be easily switched off.

Second, households are adding up their net worth. Their homes are valued at much less than they were a year ago, and prices are still dropping. Their 401(k)s have fallen by a third or more. Jobs that might have looked safe even a month or two ago no longer do. People suddenly feel much more vulnerable. To repair some of the savings shortfall, they are spending less, causing sharply lower sales of inessential goods. This, of course, is putting many companies under extra pressure. As firms cut their profit forecasts -- which they are now doing en masse -- and start to lay off workers, consumers become even more worried, and try even harder to cut back. And so it goes.

On top of all this is the fog of uncertainty about where the economy is heading. Until recently, many consumers had been telling themselves that the economy and the stock market would bounce back. They seem to have changed their minds. The parallels with the 1930s that the Bush administration drew to win support for the bailout were hardly reassuring. And lately, economists have been striving to outdo each other in the gravity of their assessments. In the end, all of this alarm seeps through.

A depression like that of the 1930s seems, even now, so unlikely as to be almost impossible -- but in itself this is not very reassuring. Unemployment reached 25 percent in 1933. With government spending now much higher as a share of national income than it was back then, and with Congress, the administration, and the Federal Reserve Board all set on acting promptly and at sufficient scale, it is hard to see how a similarly massive and sustained contraction could happen again.

But unemployment in double digits -- say half of what it was in the 1930s -- is by no means unimaginable. Even if we are not headed for another Great Depression, we could easily be heading for the worst recession that most Americans have ever experienced. In fact, we most likely are.

You can read the whole article here. (The link expires in two weeks.)