It's the Consumer, Stupid

Liberals are wrong about the economy, and conservatives are wrong about the economy, Ramesh Ponnuru and David Beckworth write today in The New Republic.

Ramesh Ponnuru is wrong about the economy, and David Beckworth is wrong about the economy, Joe Weisenthal responds at Business Insider.

Here's a different perspective: Liberals, conservatives, Ponnuru, Beckworth, and Weisenthal are all right about the economy. Everybody agrees that little guys are the engine to economic growth. Liberals call them "folks", conservatives call them "small businesses", wonks call them "consumers." The point is, they aren't GE. There isn't one of them. There are millions of them, and until we get them going, it's slogcovery as far as the eye can see.

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In their suprapartisan TNR column, Ponnuru and Beckworth find that liberals bash austerity and conservatives bash the Fed, but what the economy really needs is a little more of both. Conservative spending plus expansionary monetary policy would begin the work of deficit reduction while inflating away the burden of our debts. That's half wrong, Weisenthal responds, since the economy's pains principally come from a lack of demand. And a lack of demand principally comes from household debt. He writes:

Government debts and private debts mirror each other, so that when the government spends and goes further into debt, someone in the private sector is increasing their income and coming out of debt. It's pretty remarkable how perfectly the green and red lines mirror each other.

Note that there is a third source of income for the domestic private sector -- exports, the dotted line -- but at least in the medium term nobody has a good idea of how to juice exports enough to make a difference.

Right on. Saying that the economy needs (1) stimulative monetary policy and (2) spending cuts is like saying the way to put out a fire is to aim hoses filled with water at a building and hop on one foot. The second strategy is not only mostly irrelevant to your stated purpose, but also it gets in the way of your stated purpose. Spending cuts reduce the demand that businesses look for when they take out loans to expand. We could afford to reduce government demand if the private sector were growing at a healthy clip, but we haven't been living in that world since early 2007.

That bottom line is that it's the consumer, stupid. Without the middle class spending more money on stuff, nothing will get better quickly. Not hiring, not investment, not incomes, nothing. Instead, some things will get better slowly, like unemployment claims, and other things won't get better at all, like long-term unemployment. There are a couple of ways to get the middle class to spend more money on stuff:

(1) The elected government can give them more money with stimulus, or it can leave them more money with tax cuts.

(2) The Federal Reserve can inflate the value of their debt with more aggressive monetary policy.

(3) Other countries can buy lots of our stuff and stimulate exporters who hire more people...

(4) ... or most companies, which rely on domestic rather than foreign demand, can decide that their business outlook is awesome and start hiring people. But domestic business outlook relies on domestic consumers just as much as total domestic consumption relies on businesses hiring more people. That's why this recovery stinks. Consumers and employers are waiting for the other to make a first move and make it stick.

To work backward through these choices, a secular private sector recovery (4) looks unlikely. An export boom (3) works really well if you're a small European country who can sell to the healthy American economy, but it won't work for a big, sick American economy. The various rounds of Federal Reserve action -- QE1, QE2, the Twist -- have had the effect of luring healthy consumers into the housing market and making banks super-duper-liquid. But if you're a typical household -- who entered the economy with debt worth more than a year's salary -- the fact that interest rates are low is about as interesting to you as the median December temperature of the Seychelles Islands, because there ain't no way in heck you're ready to take on more debt. If you're a small business or community bank, low interest rates aren't irrelevant, but they're hard to act on: Why expand a risky company, or lend to a risky company, if the consumers are feeling so mopey? That leaves fiscal stimulus (1), which looks all but impossible at this point and has developed quite the bad name for itself thanks to a Recovery Act that both overpromised and under-delivered.

Every choice has a downside, but the most reasonable course of action takes us to the intersection of Ponnuru/Beckworth and Weisenthal. High deficits to take on the debts of the private sector plus aggressive monetary policies to reduce the value of debts still on the balance sheets of families and businesses. That is the most direct answer to the question, How do we get consumers to stop worrying about debt and start worrying about that next washer machine/car/home extension/tutor?