The core problem we face is not access to capital. The Treasury has already flooded Wall Street and the banking system with money, committing nearly $350 billion; the Federal Reserve Board has exchanged Treasury bills for some $2.2 trillion of troubled assets; other agencies, such as the FDIC, have guaranteed trillions more. But there has been no appreciable result. Banks will not lend because they fear borrowers will not repay; businesses will not borrow because they do not have adequate markets for their goods and services; individuals cannot and will not borrow because they do not have enough reliable income to do so.
The core problem lies on the demand side. American consumers, whose purchases represent 70 percent of the economy, do not have the purchasing power to maintain overall demand for American goods and services. Businesses will not invest unless consumers are able to buy. Exports cannot possibly fill the gap. Inadequate demand is forcing the private sector to lay off large numbers of workers, which, in turn, is further reducing the buying power of consumers. In 2008, 1.9 million jobs vanished — the biggest drop in non-farm payrolls in thirty-four years. We are caught in a vicious cycle.
As the buyer of last resort, the federal government must respond if that cycle is to be reversed. In my judgment, this will require a stimulus of about 6 and a half percent of gross domestic product, or a total of some $900 billion, spread over two years. That’s my estimate for the shortfall in private demand. But the federal government should stand ready to spend larger sums if necessary to get the economy back on track toward full capacity. The danger is not that the government will do too much; the danger is that it will do too little, too late.
Without such action, I estimate that another 3 million jobs will be lost in 2009, unemployment will rise to 10 percent of the workforce by the end of this year, and under-employment – including people working part-time who would rather be working full time, and those too discouraged even to look for work – will reach 15 percent. Without federal action, next year could be even worse.
People often ask where the money for the stimulus will come from. The answer is the same places from which the Federal Reserve and the Treasury have financed their far larger attempt to rescue the financial system. The bulk of the money will have to be borrowed from abroad, largely from China and Japan. This is less than ideal, but failure to adequately stimulate the U.S. economy, resulting in years of economic stagnation, would be far worse – both for us and for the rest of the world. Moreover, our current ratio of debt to gross domestic product is still below 50 percent, not substantially higher than that of most other industrialized nations. In 1946, our debt to GDP ratio was over 100 percent. Most of the declines in our debt-GDP ratio over the years have been achieved through higher levels of economic growth rather than through less debt. The sooner we return to growth, the better able we will be to reduce this ratio.
No stimulus can fully succeed if millions of American families continue to lose their homes through foreclosure. Housing markets will continue to decline, people cannot move to take new jobs, and industries such as construction and retail services will continue to shed jobs.
Mortgage mitigation efforts to date have failed largely because investors won’t agree to take their losses on bad investments. In my view, the answer is to enable families to write down their home mortgages in bankruptcy – just the way businesses can do with commercial property and people can do with vacation homes and investment properties. This change in bankruptcy law should be part of the stimulus plan.
Overall, the federal government’s responsibility for restoring aggregate demand is at least as great – arguably, far greater – than its responsibility for rescuing the financial system and helping U.S. automakers restructure. Without adequate demand, credit markets will continue to be frozen and major American industries will languish. Yet there is no ready formula for how the federal government should proceed because we have not been here before.
This largest and most serious economic downturn in more than sixty years will require both a willingness to try new policies and to change course if those policies appear to be ineffective relative to their costs. The danger is not that the federal government will do too much but, rather, that it will do too little.
Whatever is contained in the stimulus plan must also be clear and transparent, so that the public can know and understand what is being tried. Finally, although the ferocity of the downturn necessitates quick action, policy makers and the public will need to be reasonably patient. Even with the best of policies, a substantial and sustainable turnaround cannot be expected any time soon.