Hurricanes and Hot Air

Hurricanes have a notorious eye. I grew up in Florida and experienced a lot of hurricanes and it is true that after a hurricane hits you full force there is a time period when all again turns calm. But you know the devastation is not finished since the back end of the hurricane is coming in minutes. You have just enough time to close one set of windows and open the others to relieve the pressure that might blow your roof off and then bam along comes the trailing half. If that wasn’t enough, you know well that there is a hurricane season. Not long after you have dealt with the aftermath of one hurricane, your meteorologist warns of the next one heading your way. If the last one was a bad one, it makes you ever vigilant and always worried of impending doom despite the fact that most times most people never suffer through more than one bad hurricane in one season much less a decade.

It is human to expect tragedy to follow tragedy. Luckily when it comes to hurricanes, we don’t also have to worry that politicians will make hurricane policy the centerpiece of their campaigns for office. It is enough to deal with the uncertainty brought about by the winds. Worse can be the hot air and real policies advocated by politicians.

That little introduction brings us to the US economy right now. We had a once in a lifetime economic hurricane in 2008 known as the housing and financial crisis. The financial and housing crisis turned into a global recession. Despite the fact that the recession ended about two years ago, our policymakers seem to think we are still in the eye of the storm or perhaps between two equally devastating storms. Regardless, an impending presidential election year has these politicos acting as if we need saving from doom when in fact the worst is over and there is really very little they can do at this time to improve things. Politicians cannot benefit from that reality so they pretend like it doesn’t exist. The democrats want to pass another stimulus program they have labeled as a jobs program. The republicans play dueling banjos with their own means of stimulus. While stimulus sounds good to many people, the truth is that what we need now is a little patience and a little good policy addressed at what is really wrong with the economy.

Let me admit that I do not think that stimulus is a dirty word. When I teach macro I do cover cases where a Keynesian demand stimulus might be appropriate – usually when deficient aggregate demand is abetted by dismal expectations and spending needs a little boost. I think there have been times when such policies worked and I also think that the idea of some stimulus on 2008 was not a bad idea. I disagree with the form of much of the stimulus in 2008, but the general idea was not totally off base.

The trouble with stimulus can be likened to the idea of eating one potato chip. Maybe even one of those small bags of chips isn’t too bad now and then. But whether it is one chip or one small bag, the trouble comes when you eat 1.5 trillion of those little bags…each year.

That brings us to 2011. It is now November. Paul Krugman, Martin Wolf, and many other spokespersons for the economic left are strongly advising that governments avoid any rush into austerity programs and to immediately move to larger government deficits financed by an expansion of the money supply. This is very Keynesian stuff but 2011/2012 in no way fit the Keynesian requirements for such policies. Let me try to explain why this is medicine aimed at the wrong problem.

First, as recent economic data shows, the US economy has regained its legs. We are not ready for a marathon run, but let’s appreciate what we have. The US economy got socked by several shocks. These shocks all diminished our desires to spend. First was the diminished value of housing and other wealth that spilled over into Main Street. As sales of most goods were negatively impacted this led to layoffs and further reductions in spending. Despite the severity of all this, the economy did start to grow again and was on its way when bam along came a perfect storm of impacts from a tsunami in Japan, commodity price increases, and a whole chain reaction of supply chain disruptions. It didn’t help that Europe was falling apart and the financial impacts of the sovereign debt crisis were spilling over on wealth and spending in the US. This second storm had its predictable negative impacts on spending.

You might say – if the stimulus helped in 2008, then why not try it again in 2011? And my answer would be that while it appears like a similar situation again in 2011, it just isn’t the same. There are lots of differences. For one thing, the economy is growing now. Forecasters see further gains in employment. They are predicting that the unemployment rate will fall further in 2012 and that the economy could grow in that year by 2-3%. That is a lot different than 2008 when we had no idea when and where we would reach a floor in economic activity. The differences in consumer/business confidence are stark between 2008 and 2011.

Second, you might correctly point out that the growth of the economy at 2-3% won’t have a big enough and fast enough impact on the unemployment rate. You might add that without further stimulus policy, growth will be too slow and this will hurt too many people. But hold on Toto. Another difference between 2011 and 2008 is that we have added a massive amount to national debt with no real prospect of near term reduction. A little Keynesian stimulus when debt is a major concern makes no sense. Our credit has already been degraded. We have skated for a while as Greeks and Italians have watched their interest rates soar. But another US stimulus package will focus the world’s investors on the USA and we do not want to see what happens when they start aggressively selling US bonds, stocks, and dollars.

Third, while inflation is not an immediate threat to US citizens, it is much more a potential issue than it was in 2008. Already prices of many critical food items have risen and it is no secret that inflation is at or above what the Fed usually considers okay.   Adding too much stimulus right now just risks a return bout of inflation. Moderate growth sounds terrible for the unemployed but if stimulus-induced short-term increases national spending, then whatever help we give to the work force in the near term will soon be undone by a future bout of stagflation. Inflation is no friend of the worker.

   

Finally, a return to fiscal and/or monetary stimulus simply interferes with doing the right thing. I am not in favor of an extreme short-term loaded austerity program. But I am for a quick agreement that would set out the size and parameters of a medium term program to reduce the size of government deficits. I also favor a faster and clearer attempt to address housing and financial problems. It is possible to find solutions for specific financial problems that do not create a moral hazard for the future. The depth of the financial problem does require that investors and tax payers share in the support of the solution.

In sum, neither a quick stimulus nor austerity will help us improve the US economy. Both will make us worse off. What we need to do is address the real causes of slow growth – out of control private and public debt. Once investors and business firms see that sensible policies are being put into play then you will see some real progress in economic growth and employment. In today's environment of political frenzy it is hard to imagine a good ending.