It appears that Barack Obama has noticed there's an elephant in the room.  An elephant called "entitlement spending", which has over the past forty year slowly digested virtually the entire nondefense federal budget.  Apparently Medicare and Social Security spending are on the table (at last?).  I welcome the consideration, although the last time this happened (under a supposedly conservative President) we got a new liability (the Medicare prescription drug benefit) without any corresponding cuts in benefits.  If anyone's asking, I'd propose raising the eligibility age somewhat, and tightening up what counts as "disabled" for Social Security.  I've met several people whose only disability was terminal laziness (and I imagine that wasn't what Roosevelt had in mind).

Also, the best short article on stimulus I've seen yet, from a man with a very impressive job you wouldn't think existed unless you thought about it: the Chief Economist for Google, Inc., Hal (No relation to the computer in "2001: A Space Odyssey") Varian.

[In which it is pointed out that the sky is not, in fact, falling, and that rumors of the fall of the American Republic, economy, and way of life have been greatly exaggerated.

Often, on purpose.]

It is fashionable in wonkish circles now to compare the present difficulties of the American economy to the Great Depression of the 1930's.  There are a few decent reasons for this (largely that things have been going so darned well since the 1930's that we have little else to compare it to if we want to imply that things are bad, and many people do), a few halfway decent reasons (it's attention getting!), and a few less savory (See Below).

The champion of the breed is probably Paul Krugman, who finds it difficult to complete sentences without using the words "depression", "Roosevelt", and "stimulus" these days.  Krugman is a great economist, but he's also a committed ideologue.  Very much like Milton Friedman, in that way.

Here's the thing.  Paul is interested in expanding government (he calls himself a progressive).  So fiscal stimulus, for him, isn't a means to an end, it is the end.  When he talks about expansion of employment due to government spending, he's talking about ideological victory.  Of course I'm not bashing Paul's ideology, nor are liberals solely responsible for the crying of wolf over the economic situation.  They just happen to be in charge right now, so they have control over the policy levers and buttons.  The point is that economic crisis permits much more far reaching and outlandish policy ideas to be considered (imagine proposing national public make-work programs under Clinton).  It's a great opportunity for anyone (anyone!) with a partisan or special interest axe to grind.

The facts are different.  Krugman himself notes that unemployment is 7%ish, and cites rhetoric from Obama that it might get into double digits.  Unemployment in the Depression was 20% or more.  In France, 7% unemployment would make policymakers heroes.  We are, at present, in the midst of a painful and ugly economic downturn, which appears as if it might be as bad as the 1981-1982 recession brought on by Paul Volcker's fight with the Demon Inflation.

It could still get worse.  2009 is going to be tough.  But there are reasons to think that the free fall is over.  CalculatedRisk has observed meaningful improvement in financial markets.  Home prices have fallen back to relatively reasonable levels in the bubble areas (though they have further to go).  And since this is our first real recession since 1991, we ought to expect a little bit of ugly for putting it off so long.

So when someone tells you the sky is falling, look around.  The situation is not that bad, and there isn't any indication that it will be.  Look at that person's agenda, too, and how they might have an angle, some hoped for benefit from your panic. 

This post is intended as a thoughtful and serious response to Randall Wray's "Policy Advice for President Obama (Part One)".  I decided I was likely to go on far too long for a good comment, because his advice to Obama is obviously the product of long thought on these issues.  Obviously, if I just agreed with him, I would have said so in the comments without the necessity of this post.  I'll take his points in order, breaking out sub issues where they arise.  I'm going to leave the overall issues ("Stability is Destabilizing") for another time and talk brass-tacks-policy.

1. Liquidity: Wray seems to be conflating two very separate issues here.  One is (obviously) liquidity, which is very much the Fed's job, and I agree that the Fed should have made money available faster than it did (such a thing being possible).  However, the FDIC, and deposit insurance generally, is a different matter.  Deposit insurance really is insurance; banks pay in, and depositors are paid out if the banks fail.

There's no reason to change the rules and raise deposit insurance limits after the fact.  To the contrary, it is important (for moral hazard reasons) to stick to the rules as written.  The $100,000.00 (or whatever number on whatever date) deposit insurance cap is a safeguard for the taxpayer.  Protecting depositors is the same as protecting any other lender; the taxpayer should not automatically cover their losses.

2. Paulson: Actually the capital injection plan has not been a complete disaster.  Government financed consolidation is a terrible idea, but hardly a big deal.  Nothing Paulson has done has changed the situation one way or the other, really.

3. Insolvency: Unfortunately, while the first statements in this section are admirable (a discussion of the accounting rules that determine insolvency would be helpful, but would muddy up the story as well), the remainder is nonsense.

Once again, the zeal for protecting lenders and depositors is misplaced.  Except to the extent of FDIC insurance, and equity if there is any, lenders and depositors should take the loss.  Taxpayers didn't risk their money on these banks, lenders (including uninsured depositors) did.  Also, closing a bank increases the losses to taxpayers; a going concern, even one operated by the FDIC, is better for the FDIC's principal (the taxpayer).  You can't close the bank and then wait for an economic recovery...

At this point, a pattern is emerging.  I think Mr. Wray is too eager to avoid collateral damage at taxpayer expense.  Most of the collateral damagees knew what they were getting into, and America has an interest in them taking the loss: we have an interest in ensuring that future actors recognize risk.

This is a reason to avoid too big to fail and too big to save as mantras.

4. Tax Relief: I question the use of a payroll tax holiday; payroll taxes feed into the trust funds that fund the enormous and too often ignored liabilities of the government: Social Security and Medicare.  (I can't say this often enough: George Bush wasted more money in ten minutes signing the prescription drug benefit for Medicare than he did in eight years at war).  We ought to look for ways to deny the government money to the general fund (or at least reduce somehow the future liabilities of Medicare and Social Security - probably by indexing them to prices rather than wages).

Also, at 6.2%, payroll taxes aren't at a marginal rate which substantially affects incentives to work and invest.  Cuts in marginal income tax rates would be more effective in stimulating economic activity.  Still, one cannot pretend this is a serious distinction.

5. I am impressed by the attention to state and local governments, a facet of this problem I have seen too infrequently mentioned.  Many states and localities are -raising- taxes in order to meet their boneheaded "balanced budget" requirements or for other reasons.  State highway funds should get block grants too; states all have plans underway or on the shelf for new highway money.

On infrastructure spending, none of it will get underway anytime soon unless there is also legislation exempting the infrastructure projects from the Federal, State, and Local regulations that make these problems take decades or be shelved.  Everything from the EPA to the EEOC to the State Historical Preservation Office of New Jersey needs to be explicitly preempted by Federal legislation in order to get infrastructure projects underway and money spent before the recession is over, even if we take advantage of the States' better planning and situation for beginning these projects.

6. Mortgage Relief: Here's where we part company.  Why is Wray so eager to protect stupid homeowners who got in over their heads, while so eager to slap down stupid bankers who got in over their heads?  These people weren't "duped", they got all the paperwork, and if they didn't read it, they should have.  Taxpayer money should not be used to protect fools from their comeuppance, even if they are individual fools rather than corporate fools.

This is a serious moral hazard issue, and it is just wrong to take money from responsible taxpayers and give it to idiots who took on payments they couldn't afford.

On a related note (according to Wray, since this is the only time he mentions deflation) debt deflation cannot occur unless there is deflation.  There will not be deflation unless the Fed fails to print enough money.  The Fed has shown little shyness in that department of late.

7. Criminal Prosecution: Again, Wray is quick to get on the mortgage lenders, but fails to mention prosecuting all the mortgage holders who lied on their loan applications, and are guilty of fraud.

Myself, I think it's a waste of time and money better spend on roads, trains, fiber optic pipes, and basic research.

This is Cliffs' Notes, folks, so if you have questions or want elucidation, ask and ye shall receive.