More Fiscal Stimulus is Needed to Reverse Economic Decline

Original Link: http://www.cepr.net/index.php/op-eds-&-columns/op-eds-&-columns/more-fiscal-stimulus-in-needed-to-reverse-economic-decline/

By Mark Weisbrot

In February the Congress approved $787 billion of federal spending, in order keep the economy from sinking into a deeper recession. However it is increasingly clear that this is not enough, and a third stimulus (the first was a small stimulus package early last year) will be necessary.

About $584 billion of the stimulus package will be spent over the next two years, in order keep the economy from sinking into a deeper recession. This sounds like a lot of money, but it is only about two percent of Gross Domestic Product (GDP) over the next two years. Our economy shrank at an annual rate of 6.3 percent in the fourth quarter of last year; economists surveyed by the Wall Street Journal project negative 1.4 percent for 2009, with recovery beginning in the second half. However these forecasts have been over-optimistic in the past -- most economists missed the housing bubble and the disastrous impacts of its inevitable collapse.

In short, we really don’t know where the bottom of the recession is, or whether a prolonged period of high unemployment and weak growth will follow. There has been a lot of emphasis on curing the ills of the financial system, and this is surely necessary for a sustained recovery to take hold. However it is not sufficient. Even if the U.S. Treasury’s latest plan were to restore solvency to the entire financial system -- and this seems very unlikely -- we would still be facing a serious recession in the real economy. Even solvent banks are not going to increase lending if there are no additional credit-worthy borrowers seeking loans.

The latest data on home prices reinforces this point. The decline in home prices is still accelerating, with the 20-city Case-Shiller index falling at an annual rate of 26.5 percent over the last quarter. Home prices have further to fall to get back to their pre-bubble trend levels, and they could even overshoot on the down side: people who lose equity in their homes when prices fall cannot afford a down payment (now raised to 20 percent) for a new home when they have to move, and rising unemployment and foreclosures add to the oversupply of housing.

The global economic outlook is also worsening, with the OECD now forecasting a phenomenal 2.75 GDP percent decline worldwide. Although the United States is fortunate in this respect to export only about 11 percent of GDP, shrinking global demand and an overvalued dollar do not offer much hope for trade to boost the U.S. recovery.

The household savings rate collapsed to zero in 2007, from an average of 8 percent in the post World-War II era. As savings recover to more normal levels, it means that consumption, which is about 70 percent of the economy, must fall. This can also further discourage investment and add to the cycle of declining output and employment, as well as the fear and pessimism that exacerbates it.

My colleague Dean Baker has put forth a plan for the government to provide a tax credit to employers for health care and also to increase employees’ paid time off – in the form of reduced hours, additional vacation, sick leave, or other days off. This has the advantage of injecting money very quickly into the economy with minimal bureaucracy or waste. If these credits cause employers to reduce average hours per worker by just three percent, this would add 4.2 million jobs at the same level of output.

With the collapse of private spending, it is clearly up to the government to rescue the real economy, and ideological prejudices must be swept aside. It is time for our government to consider some fresh ideas that can be implemented quickly.