Macro Economics
Of Course Stimulus Can Work

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By RodgerRafter
February 2, 2009

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Part of the reason we're in this big economic mess is because of overstimulation in the past. Easy credit allowed companies to take on too much debt and excessive government spending has left the Federal government in a $10+ trillion hole. 

More stimulation is going to lead to more problems down the road, but that doesn't mean it can't help be used in ways that improve our situation. Unemployment levels are undesirably high and causing economic and social damage. We need to stimulate the economy to get people working in ways that create both immediate and long term value for the country as a whole.

A year ago, stimulus checks were sent out as a way of trying to boost the economy. The action was also probably too early given that unemployment hadn't risen very far at that point. The money was mostly saved (or used to pay down debt) and it didn't have much impact on job creation. Simply exchanging government debt for consumer debt doesn't have much of a positive impact. 

When the government runs a deficit somebody else ends up making a profit. If its a tax rebate then a consumer likely ends up with more savings. If it's a government contract then a corporation probably ends up making greater profits and employees end up taking home more pay. Of course all types of stimulus will work to boost the economy to some degree. Some types will work better than other types and those focused on creating productive jobs are the ones that will work best. 

As our trade gap rose to over $700 billion per year the debts piled up in various sectors of the economy. Mortgage debt, facilitated by over-inflated home prices was the most obvious, but the debt was everywhere. A large portion of it was on the balance sheets of financial companies who hid the risks by overestimating the value of their assets, and they imploded dramatically when asset prices fell. A big chunk went into all the companies taken over by private equity partnerships that are now facing potential collapse. Another huge chunk was added on to the national debt. 

All it took for the financial crisis to begin was for the trade gap to stop growing. We peaked in 2006 with a trade gap of $753 billion. It declined to $700 billion in 2007 and it looks like 2008 will come in around $660 billion. If oil prices remain low then we might get down to around $400 billion for 2009. Fortunately low resource prices should mean that money spent on stimulus can go to more job creation. 

For a truly sustainable economy we should have little or no trade gap. By running a large one we were providing a major stimulus to our economy, and especially to the retail and financial sectors which grew far too large. As the amount of goods we import declines and the retail and housing sectors contract new jobs should be created in domestic construction and various types of services. Stimulus that merely boosts spending on imported consumer goods will lead to greater problems down the road as we find ourselves in a deeper financial hole.

So far there hasn't been a shortage of foreign investment capital to buy up our government debt and perpetuate the trade gap. As exporting countries struggle with their own economic contractions they are reluctant to let the dollar weaken too much against against their own currencies. This may change over time as global conditions stabilize and the unique vulnerabilities of big, overstimulated, debtor nations like the US and UK are exposed. 

The Federal reserve is acting to keep interest rates low and reduce the impact of our already outsized debt. They will likely intervene by creating new money to buy up unwanted treasuries if and when foreign demand for securities fails to meet the treasury's demand for funds.

One of the main complaints about the Obama's stimulus package was that it will be too slow in taking effect, but we're dealing with a problem that is very long lasting. We need to rebuild our economy for sustainability and this will be a process that continues through most of Obama's first term. 

This is probably the first of several spending bills that will be introduced to Congress as conditions worsen. In my view it had way too much emphasis on getting money into the hands of consumers and not enough emphasis is being put on basic job creation. Perhaps there is still a strong political motivation to meet some of the Republican desire for additional tax reductions and to keep spending increases somewhat restrained.

I expect conditions to worsen and future stimulus bills to come in forms that will meet other basic societal needs as they become more pressing. Aid to states may be the most immediate need for federal funds to avoid severe job and service losses. Health care reform will probably be handled in a way that includes substantial job creation. Education reform could take a similar route. Our society needs a basic safety net for the poor and homeless and once a big enough population falls deep into poverty such a need might finally be met. 

Nothing comes free here. We're likely to see either high inflation or increased taxation that will lower overall standards of living. That decline of standard of living was an unavoidable effect of living beyond our means for so long and running up huge debts to foreigners. However, we would see a big improvement in our quality of life if that is the driving force behind the choices of stimulus projects.

Our focus has long been on quantity of wealth over quality of life because the people in position to shape policy have measured their success in terms of dollars. Quality of life is what really matters for the rest of us. As wealth accumulation becomes an impossible goal for a greater number of people we may finally see quality of life improvements become the greater political goal.

Trade Gap by Year:
1992 -39,212
1993 -70,311
1994 -98,493
1995 -96,384
1996 -104,065
1997 -108,273
1998 -166,140
1999 -265,090
2000 -379,835
2001 -365,126
2002 -423,725
2003 -496,915
2004 -607,730
2005 -711,567
2006 -753,283
2007 -700,258