Let's Spend and Spend, but Avoid Bad Spending
This is a tough situation. I don't want to just parrot Paul Krugman, but I find it hard to disagree with much of what he has to say in this book.
So, I will take a slightly different tack. Paul is absolutely right that we must spend big time right now. This is a situation in which, to refer back to Keynes, completely wasteful forms of spending would be better than no spending at all. We must generate demand, and in this respect paying people to dig holes and then fill them up again is better than doing nothing.
Of course, we can find useful forms of spending and this is the great opportunity offered by the crisis. We can use the stimulus to jump start health care reform. We can also use it to get the economy on a green growth path. We have to talk about spending vast amounts of money ($500 billion to $600 billion a year), so it is feasible to talk about pursuing both goals at the same time.
However, it is also important to avoid bad spending - forms of spending that are actually harmful. At the top of this list (after unnecessary wars) is spending that could prevent the housing bubble from deflating or possibly even re-inflate the bubble. This is worth mentioning because the Bush administration is continually throwing out proposals that seem to have this as their objective.
Several Bush administration officials have suggested reducing mortgage interest rates to 4.0 percent, or possibly lower, with the intention of boosting the housing market. While there are markets in which it would be reasonable for the government to intervene to prevent a downward spiral of house prices, it is difficult to see anything good that would come from delaying a full adjustment in the markets that have still yet to fully deflate.
If extraordinarily low mortgage rates can succeed in preventing prices from falling back to trend levels, then house prices in these markets will presumably plummet when the economy recovers and mortgage interest rates return to more normal levels.
It was bad enough that the government allowed the housing bubble to grow to such dangerous levels, thereby leading tens of millions of homeowners to believe that they were wealthy based on transitory housing bubble wealth. As a matter of government policy, are we now going to deliberately try to re-inflate the bubble, so that millions of additional homeowners can buy houses at bubble-inflated prices?
If the economy has recovered in a few years, it may be less of a crisis if home prices again resume their downward course, but it will not be funny to the millions of homeowners who see their life's savings vanish in this story. There are very good ways to boost the economy out of this slump like providing universal health care coverage and promoting a green economy. There are less good ways to spend money that will also provide a boost to the economy. However, it is important to avoid really bad forms of spending - like temporarily re-inflating the housing bubble - which will lead to serious pain for many people a few years down the road.
Dean, your concern about not reflating the housing bubble seems wildly misplaced to me. For one thing, unless people are buying houses in anticipation of being able to sell them at a higher price in the near future, you don't have a bubble. Efforts to stop the nominal price of houses from falling further (like 4% mortgage rates, etc) would not create such expectations. But they might give homeowners (and mortgage holders) some breathing room, so that the real price can fall (assuming we can deter incipient deflation) more gradually over time. Simply allowing the nominal price of housing to fall contributes to the risk of debt deflation, which makes overall recovery much more difficult. Maybe the mechanisms recommended by Paulson & co. are dumb ideas, but your post seems unduly Austrian in wanting to purge the excesses.
December 15, 2008 5:26 PM | Reply | Permalink
Dean's on his "housing bubble" and his "millions of homeowners" to see their "life savings" -- all amassed between 2003 and 2007, presumably (he must think the country is occupied by squirrels --they live 4-6 years, right?) "vanish" kick.
The central point, though -- unexamined davening to Krugman and Keynes -- does deserve discussion.
Keynesian remedies -- spend, spend, spend -- are appropriate only in situations for which Keynes recommended them. And he only recommend them in the case of a country which was experiencing demand destruction in its exports -- for example, a country like the United States of 1929 and thereafter whose GDP was heavily dependent upon exports and which was carrying a large current account surplus -- a country like today's China.
Keynes did not recommend "spend, spend, spend" for countries in the situation of England, France and Germany in the 1930s or therefore by analogy, countries like the United States, today.
So why is this Keynesian policy being called for as a solution in a situation which is in no way analogous?
December 15, 2008 5:34 PM | Reply | Permalink
Except that WWII spending seems to have validated the "spend spend spend" demand side basis of Keynesian economics, whether Keynes was speaking to that specific situation in the U.S. or not (then or now).
The fact of the matter is the largest pubic works project i human history is what got us out of the economic black hole of the 30s, and is also what sustained domestic economic stability throughout the cold-war.
I don't think it is too off-the-mark to suggest that such scale of pubic spending that was done in WWII and the cold-war can be done again but instead of building SAC missiles silos through the grain belt, we build green certified clinics and job banks. Instead of just repairing our crumbling cold-war highway system, we build free access WiFi highway system. Instead of TVA rural electrification project, we have 21st century national green-grid electrification project, etc. Instead of SDI boondoggles we invest in HHS.
December 15, 2008 7:02 PM | Reply | Permalink
The idea that WWII spending got us out of the Depression is a myth.
WWII eliminated unemployment -- any slave society (a fine description of the United States during WWII) can do that.
Far from getting the U.S. out of the depression, government policy produced living standards during WWII which were lower than they were before WWI. I don't call that much of a solution.
December 15, 2008 7:38 PM | Reply | Permalink
What rubbish, the depression was devastating because of mass unemployment. The consequences on the economy because of WWII and the aftermath, G.I. Bill, shifting of the industrial economy to both DoD and consumer production is far form myth, but a verifiable fact that it is what created the strong middle class and the largest economy on the planet.
Your rebuttal is pure nonsense.
December 16, 2008 12:17 AM | Reply | Permalink
I can't help but note that you've seconded my point -- even though you don't seem to notice you've done so.
As you say it was the policy "aftermath" -- actually, starting in 1949 -- which, in the immediate post-WWII years, included elimination of the control economy, imposition of restraints on union power (Taft-Hartley), support for housing, and reduced fiscal deficits which produced the 1949-1966 boom and ended for good the Great Depression.
WWII had little or nothing to do with it.
December 16, 2008 11:36 AM | Reply | Permalink
Textbook Keynesianism is to Keynes as Soviet Marxism was to Marx.
December 15, 2008 10:26 PM | Reply | Permalink
Congress, for more years than I care to remember, is uniquely able to pass bills, whose unknown effects or uncaring effects(by those passing the law) exacerbate or cause new problems the law was to deal with. From Work Incentive to PATRIOT, FISA II, TARP, on and on, Congress, with the jaundiced assistance of lobbyists, craft and pass bad legislation. I wait with palpating heart and bated breath for the new lows Pelosi and Reid will perpetrate on the unworthy citizenry of the US. However they and the new Administration craft economic recovery, I suggest stocking up on cheap canned goods and a good gardening book or two for your victory garden 'cause you'll need them.
December 15, 2008 6:00 PM | Reply | Permalink
As I noted in the comments in Paul's intial post, the elephant in the room is that in a collapsing job market people are not spending not just because of the wake of the credit crunch (though that is part of it) but more so because they are not willing to commit to buying anything beyond necessities, and not anything like say a new car, when they are not sure they will have a job next week.
Granted that leads to a somewhat vicious circle and self-fulfilling prophecy, but that is why massive government spending is the counter-cyclical engine that is the only thing that can get the engine cranking the other direction against that dynamic. I agree with you that it shouldn't be just any spending (even bad spending) but rather good, big spending.
Spending that creates decent wage, sustainable jobs, which create the engine that then injects money into other businesses through these new wage-earner's spending, which drives up other business, which they then staff up and order to meet that demand, etc.
So investing in and even massive deficit spending to 're-tool' the economy (not just hard infrastructure but also how core sectors of the economy are structured) you will get the bang of stimulus which is needed short-term, in that it the spending puts money into consumer pockets through jobs instead of just throwing money at the consumer. But doing it through targeting monies into infrastructure, alternative energy start-ups, retrofit greening of buildings, etc. create the job stability and solid wage jobs which are a key reason we see consumers jitters and are not spending (fear of job loss). Doing this creates jobs in key sectors which are the way out of the dead-end paths of non-sustainable lynch-pin businesses undergirding our economic engine (fossil fuel, inadiqueate healthcare system, etc.)
In other words, better to spend the money that secures and creates jobs in viable industries of the future instead of throwing good money down a sink-hole of consumer spending in businesses that are dead-men walking.
That's my take-away from the situation as outlined by Mr. Krugman and others.
The key question is how do you identify, invest in, and get those new job sectors going without dubious 'central planning' style approaches, but also have accountability that we are not simply handing out money without accountability?
December 15, 2008 6:46 PM | Reply | Permalink
This is a real dilemma, but from some simple deductions the spend, spend, spend solution seems the only sensible course. Throwing money at the banks and expecting them to loan more is insane.
1)We are in this mess because of excessive use of credit in recent decades. Today, there is not enough income flow to service the debt.
2)Trying to force banks into making even more loans to those who can't pay them back does not sound like a solution to problem 1.
3) The solution to 1 will require debt reduction and the only reasonable mechanism is default. And that will be painful as those who bought at the wrong time will likely lose their homes. Propping up home prices is not a solution to unaffordable housing.
4) Now if you are of the school that 'we must do something', then direct federal spending is the only solution that remains standing.
Simple, yes. But if the cost of 4) is hyperinflation, then that does leave the possibility of doing nothing. But politically, that is probably not an option.
December 15, 2008 6:49 PM | Reply | Permalink
I don't know what "boosting the housing market" means here. There is volume and there is price. I think it's wrong to try to prop up housing prices with artificial stimuli such as interest rate manipulations. It might be right to keep real estate agents in business if markets are too thin or stagnant, but I'm quite skeptical.
I agree with how I read Ellen that the bubble collapse didn't wipe out life savings except for some small fraction of homeowners, the people who bought into the bubble and who put their life savings into their downpayment.
December 15, 2008 7:06 PM | Reply | Permalink
some small fraction of homeowners
Alas, not so. Some *7 trillion in mortgages were written from 2000-2004. Lots of re-fi's maybe multiple ones, but the gist of the number is that 70% of the 10 Trill in mortgage debt was written during the bubble years.
The money that these people will lose is the money they spent five years ago on the master card that was linked to a HELC.
Just 'cause they spent it yesterday, doesn't mean that they can't lose it today...
*(disclaimer: numbers pulled from nether orifice, heard something like this on the radio, but I might have been high...)
December 15, 2008 11:15 PM | Reply | Permalink
. . . 70% of the 10 Trill in mortgage debt was written during the bubble years.
31% of homeowners (the Greatest and Silent Generations) have no mortgage debt whatever; most Baby Boomers bought their first homes between 1971 and 1989 and prior to 2003 enjoyed large nominal price appreciation and sizable equity growth.
Yes; if they chose to convert that home equity earned/established fortuitously before 2003 into Hummers and vacations in Cancun (Tuscany or Bordeaux for jollyroger) they've "lost" their "life savings" -- but that loss isn't due to the fall in house prices. It's due to favoring current goods and services over future ones -- and too, think of their enjoyment.
December 15, 2008 11:40 PM | Reply | Permalink
The point about "life savings" is that it doesn't really apply to people who are not in their later years. If a 60 year old bought a house in 2004 in an inflated/inflating area, and used his or her life savings to do so, and now the mortgage is seriously underwater, that means the person leveraged hugely -- a good sized nest egg would mean a large fraction downpayment otherwise.
Speculators who use their life savings may deserve our compassion somehow, as much as gamblers do.
December 16, 2008 12:01 AM | Reply | Permalink
The underlying problem is that wages have remained stagnant and families are unable to keep up with the cost of living. Most people really do not have a clue as to how much money is needed for basic living expenses.
Consider the cost of food. If you ask most family members how much they spend on food, the typical answer will be $300 per month (for a family). Occasionally, they will go as high as $600 per month.
Now consider, if someone spends $10.00 a day on food, that comes to $300 per month. $10.00 a day is real tight. For example, a potato costs over a dollar, as does a stick of butter. A can of soup will run $1.50 to $3.00
And if one eats out, as working people do, it is even tighter. At $10.00 per day, one can budget slightly over $3.00 for a meal. That won't even buy you a Big Mac, but it may get you a milk shake.
So that family of four is spending closer to $1,200 per month in food, not the $300 they claim to spend.
Add in housing expenses and the cost of purchasing a car and things like health insurance and there is not any money left over. In fact many families run into the red just with basic expenses.
In the 1950s and 1960s a family could live off the income of one person. In the 1970s women started to enter the workforce out of economic necessity. In the 1990's people started to run up their credit cards and spend their home equity just to make ends meet.
Those credit cards have dried up and many people have negative equity in their homes. Not only are they unable to borrow the money they need just to make ends meet, but they are expected to pay back that debt, often at extortionate interest rates (30% plus).
Is is any surprise that people are not spending more?
Creditors and government assume people have a lot more money than they really have. Creditors believe that people don't pay their credit card bills or default on their mortgages because they are deadbeats; in fact, they are broke.
December 16, 2008 12:08 AM | Reply | Permalink
For example, a potato costs over a dollar
I take it from this assertion that you do not (personally) wander the produce aisle of your local market.
You should be on notice, however, that if you are re-imbursing some second party shopper at the rate of one dollar per potato, you are a hall-of-fame trick.
Otherwise, carry on.
December 16, 2008 2:18 AM | Reply | Permalink
Yeah, well, trying to be fair, lessee, a potato could end up being costing a dollar if you put a whole stick of butter on it, which seems to be how this representative famiy is eating, no? Now I am known to use a lot of butter, but I must say, I would need help finishing that 1/4 lb. per day. That still doesn't get me anywhere near the $1.00, because I refuse to pay the retail for a lb. (which is still under $4.00), and stock up when it's on sale at half price, which it usually is next week if it's retail this week. I don't think highplainslawyer should run for Congress, that's for sure, it doesn't look promising for passing the grocery price test. And why is there a grocery price test for those running for office? Could it have something to do with ordinary people paying attention to how much they are paying for food, and elites not? Just sayin'.
December 16, 2008 4:30 AM | Reply | Permalink
P.S. My stay-at-home Mom with 5 kids in the 60's never bought any berries other than strawberries in season. She liked them, we desired them, but they were just too expensive. I buy them all the time, all seasons, because they are usually quite reasonable with globalization. We also ate canned vegetables, never fresh, fresh were too expensive, and newfangled frozen ones were also more expensive and didn't fit into our tiny freezer compartment. My point: a bit of the history; whiteplainslawyer's main narrative might be useful for some points, but as regards food prices as a percentage of income, whether high quality healthy eating or a diet of junk processed food, it's just plain wrong. The families who currently spend high percentages of income on food are the ones eating "takeout" all the time. And yes, the ones that do that are doing that because they work long hours and have to juggle raising a family with both parents working, that part of the narrative is true.
I think it's comes down to the question of thinking one's own labor is too valuable to spend it preparing your own food and taking more time and brain effort to buy it. I'm not criticizing the choice, merely pointing it out, that it's about labor. One of the unpaid jobs of many stay-at-home Moms of post WWII was to shop for food bargains, to pinch pennies on the food budget.
December 16, 2008 5:01 AM | Reply | Permalink
long hours
Actually, when you factor in the time demands of shopping, prep, clean up, what have you (let alone if you have four kids who each refuse to eat a different protein source....) fast food is almost free. (Except for it sucks...)
December 16, 2008 8:07 AM | Reply | Permalink
Where I live, you can get a rotisserie chicken breast and wing, a pile of rice, a pile of vegetables for about $6.50...with hot sauce. I'm not sure one could do much better buying the ingredients and cooking them oneself...leaving aside time's money value. That's pretty cheap.
December 16, 2008 10:52 AM | Reply | Permalink
Costs in SF area if you shop carefully would be under $3, leaving aside time value. But of course there is a whole range of both home-cooked and restaurant eating measured in -- price/meal, perceived value of dining experience, nutritional value of meal, and so on.
December 16, 2008 2:01 PM | Reply | Permalink