Friday, November 18, 2011

Stimulus -- Part the Fourth

So … earlier we explained why we need a new stimulus package (to reduce unemployment) and why we just can’t rely on the private sector (it doesn’t create demand). Then we addressed the complaint that the first stimulus didn’t work (it did, but it wasn’t big enough, and the economy cratered harder than we thought). And yesterday, we tackled the question of whether we can afford another stimulus (yes, at about a third of the cost of what we spent providing air conditioning for the troops in Iraq and Afghanistan).

Now we get to the fun part, spending the money. Since we’ve already calculated the costs of a $1 trillion stimulus at $7.5 billion per annum, let’s work with that figure. Also, Krugman says the Congressional Budget Office predicted a $3 trillion hole in the economy from 2009 to 2011, and that the original stimulus was too small to address this effectively. We also know that the decline in late 2008 was much greater than we thought at the time -- an 8.9% decrease in GDP, when we thought it would be 3.7%, so $1 trillion sounds like it’s in the right neighborhood.

That sounds like a huge number, and it is. But remember that our current GDP – the one we need to improve – is around $15 trillion. Big problems require big solutions.

The stimulus plan should have three prongs, namely:
  • Compensatory aid to states,
  • Aid for infrastructure repair and
  • A little somethin’, somethin’ for the people.

Let’s start with compensatory aid for the states. State (and cities) typically have a much worse time during a recession than the federal government because they (a) can’t print their own money and (b) have to balance their budgets. So when revenues decrease, states have few options save for trimming their own expenditures.

Calculated Risk, an economics blogs, says that we’ve lost 232,000 state and city jobs so far this year. And in California, things look like they’re going to get worse. From the Huffington Post:
The analyst projected that midyear cuts would have to be made because revenue in the current fiscal year will fall $3.7 billion below the $88.4 billion the governor and state lawmakers had desired. 
The cuts to be implemented after the first of the year include up to $100 million each to the University of California, California State University, developmental services and in-home support for seniors and the disabled. Community college fees would increase $10 per unit, and reductions would be made for child care assistance, library grants and prisons, among other programs. 
Because revenue is projected to fall short by more than $2 billion, the state could cut public school funding by up to $1.4 billion, though that amount will have to be determined by Brown's finance director. Besides laying off school staff, cutting expenses and dipping into reserves, the state could allow school districts to reduce the school year by up to seven days, from 175 to 168. California had 180 school days before the recession hit.
 California's unemployment rate – under 5 percent as recently as 2006 – has remained above 11 percent for more than two years.... It projects California's jobless rate will remain above 10 percent through the middle of 2014 and above 8 percent through 2017.
In short, direct aid to the states is a very efficient form of stimulus because it can prevent exactly the kinds of lay-offs and cut-backs that California is facing. Also, according to the Congressional Budget Office, they also have a relatively high multiplier effect – somewhere between 0.7 and 1.8.

So let's allot $200 billion for states and cities. That way, kids don't have to see their school years shortened by two and a half weeks.

But let's take another look at at that multiplier chart. Several things, like tax cuts, don't have very good multipliers at all (especially tax cuts for the wealthy). But there are two things with higher multiplier effects -- purchases by the federal government (which we’re not going to address, because we don't know what to suggest) and aid to states and local governments for infrastructure (which we will, because we do). Both have estimated multipliers between 1.0 and 2.5.

Why infrastructure? Aside from the multiplier, it's one of the areas where conservatives and liberals can agree. While a liberal might value infrastructure repair (and this will only be about repairs -- no new projects at all) for its Keynesian effect, a conservative might just want to get the damn thing cleaned up, especially when labor and financing costs are lower. 

And liberal economist Robert Frank and conservative satirist P.J. O'Rourke did, in fact, agree in an opinion piece for USA Today.
Our nation's infrastructure is in tatters. The American Society of Civil Engineers has identified $2.2 trillion worth of repairs needed on bridges, roads, dams, schools and water and sewage systems. And that's just overdue maintenance, never mind addition or replacement. 
Be it stimulus to the good, or deficit to the ill, the case for undertaking these projects immediately is compelling. Postponement is dangerous and expensive. Falling bridges, crumbling roads, bursting dams, moldy schools, contaminated water and leaking sewage are on no one's agenda for cutting government costs or increasing government benefits. 
And to delay infrastructure expenditure is to inflate it. For example, take a badly worn stretch of Interstate 80 in Nevada. The state's Department of Transportation says fixing it today would cost $6 million, but waiting two years would cause the roadbed to be so degraded by traffic and weather that the price would rise fivefold, to $30 million. 
That's probably an underestimate. Many construction workers are currently unemployed and equipment is idle. Two years from now, putting them to work on I-80 will mean bidding them away from other jobs. Furthermore, construction materials are cheap at the moment and interest rates are at record lows. 
Another example is a pair of bottlenecks in the Northeast rail corridor. Low clearances block flatcars from carrying double-decker shipping containers. The containers go by truck instead, mostly on I-95, now bumper-to-bumper day and night. Other trucks use I-81, which is also congested and adds 200-some miles to the trip. According to a study commissioned by the I-95 Corridor Coalition, the bottlenecks could be eliminated for a cost equal to half the resulting multibillion-dollar savings. And those savings don't include reductions in noise, air pollution and the number of furious drivers with beet-red faces stuck for hours in traffic.
The American Society of Civil Engineers may be exaggerating some (though their study was done in 2009, so their numbers may be more realistic now). But it looks pretty likely that we could spend half our proposed stimulus -- $500 billion -- on needed programs which would be more expensive to undertake when the economy recovers.

The I-35W Bridge in Minnesota, which collapsed in 2007.

That leaves $300 billion left over. And this is where the helicopter drop comes in.

The idea of the helicopter drop – where the government would literally throw cash out of the side of a helicopter – originated with conservative economist Milton Freidman as a possible tactic to fight price deflation.

Ben Bernanke spoke positively about the effects of a helicopter drop in a 2002 speech at the National Economics Club.
Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money. 
So how would this work? Easy -- we just take one of Bush's plan -- the Economic Stimulus Act of 2008 and double it. From Wikipedia:
Tax rebates created by the law were paid to individual U.S. taxpayers during 2008. Most taxpayers below the income limit received a rebate of at least $300 per person ($600 for married couples filing jointly). Eligible taxpayers received, along with their individual payment, $300 per dependent child under the age of 17. The payment was equal to the payer's net income tax liability, but could not exceed $600 (for a single person) or $1200 (married couple filing jointly).
Those with no net tax liability were still eligible to receive a rebate, provided they met minimum qualifying income of $3,000 per year. Rebates were phased out for taxpayers with adjusted gross incomes greater than $75,000 ($150,000 for couples filing jointly) in 2007. For taxpayers with incomes greater than $75,000, rebates were reduced at a rate of 5% of the income above this limit. 
And the cost of the bill was $152 billion. So we can (basically) double the payouts for all of the recipients. Single filers could get up to $1200, and married couples could see $2400. Not a bad chunk of change.

But why do this?

From an economic standpoint, the best thing would be if people were to take each and every dollar and buy something with it. A direct infusion of cash into the economy would have the greatest multiplier effect. But that's not going to happen -- but the alternatives aren't half-bad.

If you're middle or lower class, you may take that money and use it to catch up on your mortgage. That’s not a bad thing, as it would help stabilize housing prices as well as increase cash flows to mortgage holders, which tend to be things like pension plans, mutual funds and financial institutions.  It would also reduce strain on Fannie and Freddie, as more and more of their mortgage-backed bonds were being paid off. (We own Fannie and Freddie, so we've got skin in this game.)

If you’re up to date on your mortgage (or have none), you could take the cash to pay down a credit card payment. This won’t really help much in terms of stimulus, but it will, as Ben notes above, “improve the balance sheet of potential borrowers.” Meaning, if you’re thinking about buying a house or a car in the future, this should help you down the ways. And considering that the average interest rate applicable to credit cards is 15%, paying down a chunk of the principal now will significantly lower interest payments going forward -- meaning the credit card gets paid off sooner. It means the stimulus money will get spent, just not right now.

Finally, if you're upper class, you're probably just going to save this money. That, bluntly, doesn't help the economy much at all -- see the multiplier chart above -- but not every plan is perfect. And the payout to the upper class would start diminishing if you made more than $75,000 single/$150,000 married couple. So the bulk of this stimulus will be going to people who aren't going to hold onto it.

So -- there you go. A simple, three-step stimulus plan with something for everybody. Everybody (or almost everybody) gets a little ching-ching, everybody gets to enjoy social services restored to about what they used to be, and everybody gets to drive over bridges which don't collapse.

All for the low, low (real interest rate) cost of $7.5 billion per year.

Edited for clarity.

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