Folks, it is worse than you think...
Given normal uncontroversial economic formulas with things as they are today, to stimulate the economy the Fed would need to cut interest rates by 6%.
http://krugman.blogs.nytimes.com/2009/01/17/zero-lower-bound-blogging/Interest rates are at about 0%.
That means the Fed is out of bullets and the Federal government needs to do something that is equivalent to a 6% interest rate cut.
It is hard to express how much borrowing and spending it takes to approximate a 6% easing on credit... trillions, of course, but how many?
If normal trends apply we may be looking at an annual deflation rate of 3.5%. Once something like that starts there is no "natural" brake or rebound point. High across-the-board deflation is catastrophic, not some self-correcting cyclical phenomenon.
The scary thing about Paul Krugman is that he is moderate, not alarmist. But he blogs every day about 3%+ deflation and looming intractable depression. The problem is that we are in a situation where even the most conservative analysis seems crazy.
None of us know exactly what team Obama will do (including team Obama) but that doesn't mean it is irresponsible to take an interest in the survival of our own national economy. The best Democratic traditions suggest we really SHOULD think about these things.
I do not know why team Obama is playing around with this thing. The outlines of the stimulus proposed (information disseminated by T.O. for the purpose of us looking at it) suggest the thing is not only insufficient, but a particularly ineffective use of what dollars it does spend.
The people around Obama are certainly not stupid or ill-informed, so when they put out a sketch of a stupid, useless policy there's a reason for it. The reason must be politics. Obama doesn't want to take the needed gamble. He doesn't want to spend his capital trying to move something truly dramatic. And perhaps his course will keep his approval ratings higher.
I do not suggest Obama's political analysis is faulty. I suggest it is irrelevant. This is an honest to God crisis with potential outcomes that are WORSE than the great depression. Real nation destroying stuff. And the broader moral dimensions are shocking, even to the most irresponsible 'good riddance to capitalism' set. The effects of a global depression on the people of the third world would be like like a hundred Iraq wars.
But if Obama is personally inclined to think that there is a reliable self-regulating element of the situation then he might be inclined to pursue a safer course while
hoping that his political maneuvering doesn't end up tipping the country from deep shock-recession into intractable depression.
Spending $850 billion on sacks of manure and tossing them in the ocean would have some stimulative effect. You cannot spend that much money in any fashion without SOME effect. But 850 Billion that's largely tax cuts and grants to states is no game-changer. That's "waiting it out" in a situation with no obvious self-correcting dimension. (Shifting budget deficits from one government balance sheet to another is not optimal stimulus.)
Will anything I type here affect the stimulus package? No, but that goes for all of us. (If I typed that it will be the best thing ever it would be equally futile.)
But whatever magical effect our DU scribblings have, I hope this adds one voice to the needed call for
a mode and scale of stimulus that will seem outlandish. Only an incoming and wildly popular president could ever hope to pull off something truly outside-the-box. So please start from scratch and go for daring and dramatic, not slow and steady. Shoot your whole political wad on this roll because if the USA goes down then everything else you campaigned on means zero.
The greatest risk is caution.
And if we do a half-hearted ineffective stimulus and it fails then the pugs will have another generation of ammunition that government cannot help the macro-economic situation. So the stakes are even higher than high!
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Risks of deflation (wonkish but important)
There’s been some talk abut risks of deflation, but there’s one alarming comparison I haven’t seen made. The figure above shows that the CBO is currently projecting an output shortfall from the current slump comparable to the slump of the early 1980s. Actually, it’s very close: if you compare the CBO’s projections of unemployment from 2008 through 2012 with its estimate of the natural rate, we’re looking at cumulative excess unemployment of 13.9 point-years; that compares with 13.7 point years from 1980 through 1986. (If the natural rate — the unemployment rate that keeps inflation unchanged — is 5 percent, and the actual unemployment rate averages 7 percent over a year, that’s 2 point-years of excess unemployment.)
Now here’s the thing: the slump of the early 1980s produced the Great Disinflation, which brought the core inflation rate down from about 10 to about 4.
This time, however, we entered the slump with a core inflation rate of about 2.5 percent. If we experienced a disinflation comparable to that of the 1980s, that would mean ending up with deflation at a rate of -3.5 percent.
And bear in mind that neither the CBO nor the Obama team really explains where recovery comes from; it’s just assumed.
So tell me why we aren’t looking at a very large risk of getting into a deflationary trap, in which falling prices make consumers and businesses even less willing to spend. Tell me why this risk wouldn’t remain high, though lower, even with the Obama plan, which as far as I can tell is expected to reduce cumulative excess unemployment by about a third.
http://krugman.blogs.nytimes.com/2009/01/10/risks-of-deflation-wonkish-but-important/
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