July 06, 2010
David Brooks has decided to jump into the debate over stimulus with both feet. In a column in which he warns against arrogance he tells readers that additional stimulus would: “risk national insolvency on the basis of a model.”
Mr. Brooks doesn’t tell readers how he has determined that further stimulus carries this risk. He doesn’t explain how raising the country’s debt to GDP ratio by 4-8 percentage points over the next few years would jeopardize the creditworthiness of the U.S. government. This is certainly a rather strong assertion, given that even with this additional indebtedness, the debt-to-GDP ratio in the United States would still be far lower than it had been at prior points in its history.
Even after a decade of accumulating debt at a rapid pace, the U.S. would still face a lower debt burden than countries like Italy do today. Italy is currently able to borrow in financial markets at very low interest rates. Projections for 2020 show that the debt burden of the United States would still be less than half of the current debt burden of Japan, which still pays less than 2.0 percent interest on its long-term debt.
Financial markets also don’t seem to share Mr. Brooks view that national insolvency is a serious concern. The people who are putting their money on the line are willing to buy 10-year Treasury bonds at just 3.0 percent interest rates. That would seem to suggest that insolvency is not a real concern, but Mr. Brooks insists that President Obama should hesitate on stimulus because he thinks that insolvency is a problem anyhow, and the people who disagree with him are arrogant.
There also is a basic question of logic that Mr. Brooks neglects. If the country really did start to face insolvency (i.e. no one would buy its debt), why would the Fed not simply step in and buy up government debt itself, as it has been doing to some extent over the last year and a half? This could cause inflation, which could be a serious problem, but then the issue would be inflation, not insolvency.
Of course, as a practical matter, it is more than a little far-fetched to believe that we will have to worry about inflation any time soon. All the measures of inflation are in the 1-2 percent range and headed downward. With the unemployment rate still near double-digit levels and huge excess capacity in nearly every sector of the economy, it would take some real magic to spark inflation. (Since Brooks is anxious to argue that central banks and international financial institutions, who all missed the housing bubble btw, agree that insolvency is a real concern, it is probably worth mentioning that Olivier Blanchard, the chief economist of the IMF, believes that the economy would benefit from a somewhat higher rate of inflation.)
After inventing a crisis of national insolvency to concern the president (should President Obama also worry about invading Martians?), Mr. Brooks tells readers that:
“The Demand Siders don’t have a good explanation for the past two years.”
Hmmm, is that right? Seems to me that we have a very simple theory to explain the past two years. There was a huge bubble in housing that burst beginning in 2006. This led to a plunge in residential construction that cost the economy more than $500 billion in annual demand. In addition, the loss of $6 trillion in housing wealth, coupled with the loss of around $7 trillion in stock wealth, has cost the economy more than $500 billion in annual consumption demand. This is the result of the wealth effect on consumption, a phenomenon that economists have been writing about for close to a century. In addition, there was a bubble in non-residential real estate that collapsed about a year after the collapse of the housing bubble. This cost the economy about another $150 billion in demand. That gives a total loss in annual demand of around $1.2 trillion. All of this was completely predictable and predicted by at least some demand siders.
It was also easy to see that the stimulus approved by Congress was inadequate. Demand siders rely on something called “arithmetic” to reach this assessment. After pulling out the $80 billion fix to the alternative minimum tax, which had nothing to do with stimulus, and the $100 billion or so designated for later years, the stimulus provided for roughly $600 billion in spending and tax cuts over the years 2009 and 2010. This comes to $300 billion a year. Roughly half of the federal stimulus was offset by cutbacks and tax increases at the state and local level, leaving a net stimulus from the government sector of roughly $150 billion a year.
Demand siders did not believe that $150 billion in annual stimulus from the government could offset the contractionary impact of a reduction in annual spending by the private sector of $1.2 trillion ($1.2 trillion > $150 billion). That is how demand siders explained the failure of the stimulus to have much impact in reducing the unemployment rate. Perhaps this explanation is too complicated for Mr. Brooks (he repeatedly complains about the high IQs of the demand siders), but it actually seems fairly straightforward. If he wants to be honest, he could at least say that he doesn’t understand the demand siders’ explanation, rather than asserting that demand siders do not have an explanation.
Brooks has also developed his own theory of consumer and investment behavior. He decided that consumers are not spending because of concerns about the debt. This is an interesting theory. Consumer spending is probably still somewhat higher than would be expected given the loss of stock and housing wealth. (The savings rate is between 4-5 percent, compared to a long-term average that is more than 8.0 percent.) Furthermore, with many experts and media pundits (like Mr. Brooks) insisting that the government must cut Social Security and Medicare, it is really surprising that the huge cohort of baby boomers approaching retirement is spending as much as they are. In short, it doesn’t seem like the evidence fits Mr. Brooks theory very well.
Mr. Brooks also insists that concern about future tax burdens is depressing investment. This is also an interesting theory. Of course, given the extensive research showing that demand growth is the primary determinant of investment most economists might be hesitant to accept Mr. Brooks’ theory.
Brooks also tells readers that:
“it’s very hard to get money out the door and impossible to do it quickly.”
Is that really true? Suppose the government gave a tax credit that allowed firms to shorten their workweek while keeping pay nearly the same. Would this take a long time to get out the door? This policy of work sharing has prevented the unemployment rate from rising at all in Germany during this downturn and allowed the Netherlands to keep its unemployment rate close to 4.0 percent. Is it arrogant to suggest that this sort of approach could pay dividends in the U.S.?
President Obama and the Democrats are being blamed for the poor state of the economy and high unemployment. This means that the worse the economy performs, the more the Republicans benefit. If stimulus will benefit the economy, then anything the Republicans can do to block stimulus will help their election prospects. In this respect, raising doubts, even if there is no basis for these doubts, can be a very effective election strategy for the Republicans, especially if the doubts can obstruct effective stimulus not just in 2010, but up through the next presidential election.
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