Obama's pyrrhic victory on the stimulus package

Posted By Phil Levy Friday, February 13, 2009 - 3:39 PM Share

By Phil Levy

As the fiscal stimulus saga draws to a close, we can ask what this opening salvo of the Obama presidency means economically, politically, and internationally.

The economic range of reactions to the stimulus can be oversimplified into three camps. The first camp could be called the Scientific Keynesians, with Paul Krugman at their forefront. This group typically looks at what the economy is capable of producing, subtracts what it is likely to produce in this slump, and identifies the difference as a gap to be filled. They have confidence that it's possible to bring spending online in a timely fashion and fine-tune the amounts so as to produce the requisite growth and jobs. They tend to view the $789 billion package as woefully inadequate (it doesn't fill the gap) and have been highly critical.   

A second group could be called the Cost-Benefit Covey. For them, federal spending is neither good nor bad, per se. It depends what it costs and what it will do. In a time of low interest rates and idle workers, there may be projects that are worthwhile that would not pass the test when the economy is humming. But the number of such projects is limited. As Larry Summers put it, this group is looking for spending that will be "timely, targeted, and temporary." Even if there were a $1.2 trillion output gap, that does not mean so much can be spent wisely in the time the gap remains open. Members of this loosely-defined group have criticized the stimulus plan as excessive and wasteful. They are not prone to embrace John Maynard Keynes' idea that we might just as well employ people to dig holes and fill them again. Members worry about racking up enormous debts and the high taxes or inflation those debts may bring.

A third group could be called the Animal Spiritualists. The same Lord Keynes used the term "animal spirits" to describe public confidence in the economy. Such confidence certainly seems to be at a low ebb at the moment. The question is how to restore it. In this light, perceptions are all-important. If the package is seen as being significant, it will create hope, people will buy again, and the economy will revive. There's not much precision to this approach; it's mostly psychology. While the Animal Spiritualists may be happiest with the fiscal stimulus package, they would seem vulnerable to the Scientific Keynesians and the Cost-Benefit Covey. If the public believes the critiques from either direction that the stimulus plan won't work, then those critiques will be proven correct.

My own sympathies lie closest to the Cost-Benefit Covey. I have little faith that the fiscal stimulus plan will revive the economy. There is an output gap, of course, but there are also some big structural problems -- like a collapsed financial sector and a housing sector in a downward spiral. Fixing those will be a prerequisite for recovery and may require all the resources we can muster.

Politically, President Obama seems to have dashed many of his major thematic campaign promises in his very first foray into large-scale policy-making. The crafting and selling of the stimulus package have been neither transparent, innovative, calm, nor bipartisan. Much of the package was crafted behind closed doors. The rush to push money out quickly left no time to develop creative new approaches. The president's dire warnings of doom did little to soothe fears, particularly in those who had doubts about the stimulus package's efficacy. And hopes for bipartisanship may have been the biggest victim of the endeavor. While President Obama was willing to exchange pleasantries with Republicans, those Republicans were largely excluded from the crafting of the bill and voted overwhelmingly against it.

Of course, a natural response by the Obama administration is that the Republicans were just engaging in rank partisanship. There are certainly Republicans motivated solely by politics, but this is why Sen. Judd Gregg's withdrawal as Commerce nominee is so devastating. Even President Obama's hand-picked reasonable Republican found the process unpalatable.  

On the international front, the bill portends trouble. The original excesses of the Buy American clauses were trimmed back, but President Obama missed a golden opportunity. Had he embraced Sen. John McCain's amendment to remove the clause, he would have demonstrated bipartisanship, assured the world that America was not embracing protectionism, and still retained existing legal authority to direct some contracts toward domestic producers. Instead, Sen. McCain's amendment was defeated. The remaining clause sends a bad signal, allows protection, invites retaliation and risks provoking numerous trade disputes.

If worried allies wish to call up and seek reassurance, they likely won't find the right person on the other line, as key international economic positions remain unfilled: Ron Kirk, the nominee for United States Trade Representative, has not yet had hearings scheduled, and there is a new vacancy at Commerce. The Treasury, meanwhile, may be otherwise occupied.

President Obama got the stimulus plan that he wanted, but at potentially a very high cost.

EXPLORE:ECONOMICS, OBAMA ADMINISTRATION, U.S. FOREIGN POLICY
 

WOLFBOY

12:25 PM ET

February 14, 2009

Loosely defined group

So Larry Summers and the Heritage Foundation both fall into a single "loosely defined group" with a common view of what stimulus should look like? It made my head hurt to try to reconcile the two positions, along with the discussion at your link.

Are aid to states and benefits for the poor and unemployed highly effective stimulus or are they wasteful and ineffective?

Are permanent extensions of the 2001 and 2003 tax cuts temporary? Would a reduction in the top individual tax rate be targeted?

'Timely,' I note, must properly be evaluated with respect to the actual expected duration of the recession, which is now unusually long. (This same link shows that the estimated output gap is more like $2.8 T than $1.2 T).

 

ANDREWP111

3:59 PM ET

February 14, 2009

How many times can they do it?

I don't think this Porkulus will work. And if long term interest rates rise on account of the huge amount of money printing, we will have a stagflationary depression, and the Govt won't be able to do another stimulus. They will have shot their wad.

 

MIKE EDELMAN

4:27 PM ET

February 14, 2009

the one thing that this bill

the one thing that this bill doesn't do regardless
of which group you might belong to is fix the housing
problem with a solution aimed at both keeping people
from defaulting on their mortgages thereby stemming
the surging increase in housing inventory and at
the same time providing a stimulus to homeowners who
are able to remain where they are but have no discretionary
income past their housing costs. The way to do this
quickly, ie timely, and targeted is as follows:
1. the government subsidizes the difference between
market mortgage rates and a mortgage rate of 2.5%
interest only mortgage for a. qualified homeowners whose monthly payments do not exceed 33% of their NET INCOME (not their gross inc) and b. for those who are about to loose their homes. In return the government lending agency
would receive a 25% interest in any profit above market
value at the original time of purchase when the house
is sold.

2. for others able to pay they too would get a government
subsidized mortgage at 3.5%....that would be self
amortizing but would reduce their monthly payments
substantially giving them instantly more discretionary
income to spend on consumer goods. the government
would also get an interest in the profit on the
home based on the original purchase price..of 15%
if the home is in fact sold at a profit

3. new home purchasers would also be able to
buy a new home at the 3.5% rate...with the same
profit interest, they would have to be qualified
under the 30% rule..have a 25% downpayment
ie skin in the game...etc

the above would stop the bleeding in the housing
market...it would sop up excess inventory..it
would release cash into the economy and it would
stem foreclosures..

In addition FICA would be suspended for 1 year...
for all taxpayers ...no transfer payments..those
who pay taxes get a break..those who don't should
not...

FINALLY A SUNSET PERIOD OF TWO YEARS ON THE ABOVE
SO THAT BUYERS AND OWNERS WOULD HAVE TO ACT
SWIFTLY TO TAKE ADVANTAGE OF THE RATES BEFORE
THEY WOULD DEFAULT TO THE MARKET RATE...

michael edelman

see michael edelman.com

 

NATURAL PHILOSOPHER

6:12 PM ET

February 14, 2009

Stimulus

(1) The Animal Spiritualists have to be unhappy at the way Obama has been talking down the economy.

(2) You left out those of us who think, Federal spending is bad per se.

What do the Keynesians say about the depression of 1920?
Depression of 1920:
Estimated GNP plunged 24% from $91.5B in 1920 to 69.6B in 1921.
Unemployment jumped from 5% to 12%.
Decline in price deflator from 1920 to 1921 was the highest in 120 year history of time series, betw 13% and 18% depending whose estimate. For contrast, the next highest was 11.5% in 1931-32.

Greatest recession fighter in history, Warren Harding responded by slashing Fed gov't spending in half over two years, from $6.3B in 1920 to $5B in 1921 and $3.2B in 1922, vetoing various spending bills. Refrained from business bashing, cut business taxes, left tax on highest earners at 8 %. Federal Taxes fell from $6.6B in 1920 to $5.5B in 1921 and $4B in 1922.

Result: GNP rebounded from 69.6B 1921 to 74.1B 1922,
unemployment back to 6.7%,

Just a year and half after Harding became President, the Roaring 20's were underway. Unemployment continued to decline, reaching an all time peacetime low of 1.8% in 1926.

Then you have Reagan, cut taxes, discretionary spending, solved major recession. You have Bush 2003, cut tax rates, recovery. You have Hoover, upped Fed spending 50%, followed by FDR, stimulus out the wazoo, still near 20% unemployment 10 yrs later. You have Japan, stimulus after stimulus, continuing malaise.

Why is it that stimulus has never worked, and tax/spending cutting has always worked, and our fearless leaders still keep coming back to stimulus? What is the "Keynesian" explanation for the Great Depression of 1920?

 

ANDREAINNY

11:27 PM ET

February 14, 2009

Obama's pyrrhic victory

Watching the democrats congratulate each other for passing this spending package, I was reminded of their glee after they passed the first TARP.

They obviously haven't learned much.

Obama may never really get it right given the group he's forced to rely on.

 

KYLE L

6:52 AM ET

February 15, 2009

can we be fair?

The 4th category you left out for reactions to the stimulus, and the one that you, most of your readers, and the vast majority of congressional republicans likely subscribe to, is opposition to ANY stimulus bill that emphasizes spending over tax cuts. Now that's a fair position to have, but one that you should be up front about. Because if this is what you actually believe, it seems disingenuous--as it did to Congressional Dems-- to pick apart the specifics of a bill that you oppose first and foremost on core/ideological political/economic beliefs.

If you want to have a debate on supply-side versus Keynesian spending track records for American economic history, fine, and we should have it. The problem with this in Congress was that 1. Repubs didn't want to have this debate or offer sound reasoning for their beliefs--many just blindly cited anti-statist platitudes and beliefs about tax cuts rather than offering evidence; and 2. Dems are in the majority! Thus, no matter how much bipartisanship you might get, this was GOING to be a spending bill (just like if the GOP was in power it would certainly be a tax cuts bill). Congressional Republicans could have accepted this and tried to make the best spending bill they could. The vast majority, however, did not--they would offer sometimes reasonable critiques of aspects of the bill, but their alternatives would be an approach centered on tax cuts... when Congressional Dems and Obama faced this time and time again, they came to realize that bipartisanship can't go very far when the other side is simply starting from a completely different baseline.

I think the drafting of the initial House bill could have been much more transparent and inclusive. This was sloppy, Pelosi deserves blame, and Obama should have done better. That said, the complete lack of Republican imagination to work within the Dems' starting point (that it would be primarily a spending bill) did no service to their party in House negotiations. Contrary to the House starting point, I found Senate negotiations to be much more open and inconclusive from the start. Again, without Republicans offering alternatives that Democrats could realistically accept (think: McCain's alternative bill emphasizing tax cuts!), they couldn't realistically expect to play a constructive and influential role in the process. In contrast, when 3 moderate republicans in the senate did precisely this, they wielded considerable power. By the time they needed to work out a conference bill, what's the point in including republicans who have shown that they will never support a bill that emphasizes spending over tax cuts to begin with?

I don't think you belong in the Cost-Benefit Covey group, and I think you are misrepresenting that group's (if it is actually a group) reaction as totally negative, when instead I've found it to be widely mixed. The fact is that as cut and dry as you make the problems with the stimulus bill appear here, there are huge disagreements among experts over whether shovel-ready infrastructure projects, longer term investments in education and new technology, or quick and direct aid to states would work best to stimulate the economy right now, and you are going to find vehement disagreements and objections as you add more money to one of these types of spending projects at the expense of another, etc.

Finally, in a bill as large as this one, everyone who wants to be critical of it can find things they do not like. My point is that when Congressional Republicans and, I suspect, people like you oppose the bill already as the wrong type of basic, fundamental approach to economic crisis (spending instead of tax cuts), it is much harder to take your problems with specific components of the bill seriously. I think this is what happened in Congress, and despite my own reservations with aspects of this bill, I probably would have done the same thing in respect to Congressional Republicans that Obama and the Dems did.

In the future and more generally, I hope that this blog will learn to begin from more even-handed starting points when assessing the Obama team's performance. Big mistakes will be made, and indeed have been made already (the census debacle!). Yet I didn't think this site was designed to be a constant attack machine. If the bloggers would occasionally and honestly note Obama's successes or defend his perceived but not actual mistakes, it would make the critiques here much more convincing. I was hoping this would be a place for critical but fair evaluations of the new president. Thus far, it has just been critical.

 

TAIJI218

2:45 PM ET

February 15, 2009

A Fourth Group Almost Never Mentioned

Phil Levy's commentary was excellent overall, and his preference for the Cost-Benefit group of reactions to the stimulus is the best of the three he mentioned. However, he left out the Fourth Group, which is amazingly left out of most economic discussions: the Austrian School of Ludwig Von Mises.

The "Fourth Way" of Von Mises would argue that government intervention in the economy, which has been progressively accelerating in our society since 1912 and which now seems to be hot-rodding towards the cliff it unwittingly aimed itself at nearly 100 years ago, is virtually the sole source of the problems plaguing our economy. Expecting the government to bail out the economy when it originated the fundamental problem in the first place is akin to taking a shot of vodka to clear a hangover: it feels good at the time but really only exacerbates the problem of looking at alcohol as a solution to one's ills, rather than an amplifier.

Money is not wealth. Injecting more money into the economy doesn't boost productivity, it merely shifts economic activity from private initiative to federal, while diluting the value of the money supply in the long run (inflation). Inflation invites corruption, which we're seeing aplenty right now, even if you generously grant politicians the moral benefit of the doubt and claim they are well-meaning.

What we should do will not happen: take our consequential medicine and let failing institutions fail. The pain would be most intense but brief. It's what Hoover should have done. It's what Roosevelt should have done rather than try to extend and expand on Hoover's "socially protective" policies. It's what Obama should do.

Will he?

Don't hold your breath.

He and his buddies like the power of "rescuing us" too much.

 

Shadow Government is a blog about U.S. foreign policy under the Obama administration, written by experienced policy makers from the loyal opposition and curated by Peter D. Feaver and William Inboden.

Read More