It was striking at the DC conference on America's Fiscal Choices that liberal economist Paul Krugman and conservative economist Martin Feldstein agreed the country urgently needs a really big stimulus – three times the size of the 2009 stimulus – to fill a $1 trillion dollar GDP gap.
Paul Krugman said he expects rising unemployment over the next few months, and not much improvement in 2011. Asked when the economy would return to full employment, he responded that – absent some very big event – the “maximum likelihood estimate” for a return to full employment was “never.” To improve the jobs situation, Krugman wants policy makers to “do everything you can,” including a big monetary and fiscal stimulus to get private investment going.
Conservative economist Martin Feldstein said he “didn't disagree” with Krugman. The economy, he noted, faces a GDP gap of $1 trillion, almost as large as at the beginning of 2009, and will require a stimulus big enough to fill that gap if jobs are to improve. The $800 billion stimulus the Obama Administration passed in 2009 was meant to be spent over two years. The $300-$400 billion spent in 2009 and in 2010 was “not nearly big enough,” and the economy “never got lift off.” Feldstein admitted that he, like some of the economists advising President Obama, underestimated the size of the economic problem in 2008 – 2009.
Jan Hatzius of Goldman Sachs raised the serious possibility of another recession in six to nine months due both to fiscal restraint at the federal level as the 2009 stimulus is exhausted and to cuts at state and local levels as state governments close gaping deficits in state budgets. The key to whether this fiscal restraint pushes the economy back into recession is the housing market. A further significant decline in house prices could turn a pretty bad outlook for employment into a very bad outlook.
Feldstein made a similar point, arguing that with growth so slow, an adverse event will really hurt. A further decline in house prices could again destabilize the economy. Falling house prices, in Feldstein's view, could lead more of the 30% of households with mortgages that are underwater to walk away, increasing the supply of foreclosed homes and driving house prices lower yet. He agreed that it was critical to “fix the situation for home owners.” Dean Baker's plan to keep underwater and distressed home owners in their homes for a protracted period as renters paying the market rent looks timely once again.