Time For the Third Stimulus Package

According to Paul Krugman “voices calling for stronger stimulus are, may I say, sorta kinda respectable — several Nobelists in the bunch, plus a large fraction of the prominent economists who predicted the housing crash before it happened.”

Professor Krugman provides a link to those who argued that the second stimulus was too small, as well as to those who are already calling for a third stimulus. Three UMKC-affiliated professors are listed, including yours truly. With some immodesty, I’d like to point out that Wynne Godley and I were already calling for a stimulus package in 1999. We were worried that a tightening fiscal stance forced our economy to rely on unsustainable private sector deficits. We said:

“Growing government budget surpluses combined with growing trade deficits have generated record private sector deficits. Unless households continue to reduce their saving—creating an increasingly unsustainable debt burden—the impetus that has driven the expansion will evaporate.”

Of course the economy did quickly collapse into recession, but emerged due to restoration of a budget deficit plus a growing domestic private sector deficit. Over the years, many of us continued to warn that the budget remained too tight while private sector deficits were unsustainable. It all went on far longer than we expected, which does not prove us wrong but rather means that the slump will be immensely worse than it would have been had it come to an end earlier. That is why many of us believe the stimulus is orders of magnitude too small. The private sector is left with a monumental debt overhang and things will not get better until private balance sheets recover.

The best thing that the government can do now is to stop the job losses and to start creating jobs. We are not talking about a couple of million new jobs at this point—we need 6.5 million to replace those already lost, plus another 1-2 million to provide jobs for those who would have entered the labor force (high school and college graduates, for example) if the economy had not collapsed. Reports this morning show that President Obama’s approval rating is falling—below 50% in the swing state of Ohio—and job loss is a big part of the reason. Pessimism is setting in and it will be hard to overcome because it is well-founded. Job losses are devastating for communities—retailers are hit, real estate prices continue to fall, and state and local governments are forced to cut spending.

Many are looking back to 1937, when fiscal policy inappropriately tightened and threw the economy back into depression; indeed the collapse in 1937 was faster than the original crash that started the Great Depression off. To some extent that is not the correct analogy because most of the second stimulus package has yet to be spent, and recent data reported by Mike Norman shows that the federal deficit has actually increased in recent days. But it is still not enough, as evidenced by the growing economic stress around the country.

I realize that it is important for Congress to settle on some dollar figures for a third stimulus because that is the way that budgeting works. But in truth it is impossible to say beforehand how much we will need to stop the carnage. As James Galbraith has been warning, it is better to err on the upside. So far we have done the opposite—with the predictable result that the economy continues on a path toward another great depression.