More fiscal stimulus is needed to reverse economic decline

By Weekly Archive On Apr 29, 2009

In
February the Congress approved $787 billion of federal spending, in
order keep the economy from sinking into a deeper recession. However
it is increasingly clear that this is not enough, and a third
stimulus (the first was a small stimulus package early last year)
will be necessary.

About
$584 billion of the stimulus package will be spent over the next two
years, in order keep the economy from sinking into a deeper
recession. This sounds like a lot of money, but it is only about two
percent of Gross Domestic Product (GDP) over the next two years. Our
economy shrank at an annual rate of 6.3 percent in the fourth quarter
of last year; economists surveyed by the Wall Street Journal project
negative 1.4 percent for 2009, with recovery beginning in the second
half. However these forecasts have been over-optimistic in the past
— most economists missed the housing bubble and the disastrous
impacts of its inevitable collapse.

In
short, we really don’t know where the bottom of the recession is,
or whether a prolonged period of high unemployment and weak growth
will follow. There has been a lot of emphasis on curing the ills of
the financial system, and this is surely necessary for a sustained
recovery to take hold. However it is not sufficient. Even if the U.S.
Treasury’s latest plan were to restore solvency to the entire
financial system — and this seems very unlikely — we would
still be facing a serious recession in the real economy. Even solvent
banks are not going to increase lending if there are no additional
credit-worthy borrowers seeking loans.

The
latest data on home prices reinforces this point. The decline in home
prices is still accelerating, with the 20-city Case-Shiller index
falling at an annual rate of 26.5 percent over the last quarter. Home
prices have further to fall to get back to their pre-bubble trend
levels, and they could even overshoot on the down side: people who
lose equity in their homes when prices fall cannot afford a down
payment (now raised to 20 percent) for a new home when they have to
move, and rising unemployment and foreclosures add to the oversupply
of housing.

The
global economic outlook is also worsening, with the OECD now
forecasting a phenomenal 2.75 GDP percent decline worldwide. Although
the United States is fortunate in this respect to export only about
11 percent of GDP, shrinking global demand and an overvalued dollar
do not offer much hope for trade to boost the U.S. recovery.

The
household savings rate collapsed to zero in 2007, from an average of
8 percent in the post World-War II era. As savings recover to more
normal levels, it means that consumption, which is about 70 percent
of the economy, must fall. This can also further discourage
investment and add to the cycle of declining output and employment,
as well as the fear and pessimism that exacerbates it.

My
colleague Dean Baker has put forth a plan for the government to
provide a tax credit to employers for health care and also to
increase employees’ paid time off — in the form of reduced hours,
additional vacation, sick leave, or other days off. This has the
advantage of injecting money very quickly into the economy with
minimal bureaucracy or waste. If these credits cause employers to
reduce average hours per worker by just three percent, this would add
4.2 million jobs at the same level of output.

With
the collapse of private spending, it is clearly up to the government
to rescue the real economy, and ideological prejudices must be swept
aside. It is time for our government to consider some fresh ideas
that can be implemented quickly.

Mark
Weisbrot
is co-director of the Center for Economic and Policy Research, in
Washington, D.C.

This
column was taken from the Center for Economic and Policy Research
webpage.
http://www.cepr.net/index.php/op-eds-&-columns/op-eds-&-columns/more-fiscal-stimulus-in-needed-to-reverse-economic-decline/