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.

Stimulus -- Part Three. Ish.

Over the past couple days, we’ve fielded a few questions from the Ochreous Man as a way to introduce a discussion of a new stimulus plan to reduce the number of unemployed (the U3 number, and about 14 million) and underemployed (the U6 number, and about 25 million).

John Boehner -- The Ochreous Man
(hat tip Up Verses Down)

We’ve shown that hiring somebody is different from creating a job, which is (one reason) relying on employers won’t help reduce unemployment. And we’ve shown that the original stimulus plan, far from being a flop, was actually a pretty decent success. It was, however, just not big enough.

So today we’re going to start talking about the stimulus plan itself …. Oh, crap. You again?

We're broke. Let's be honest with ourselves.

Rep. John Boehner

Gott im himmel. 

We’re not broke. In fact, it’s pretty much impossible for a sovereign state like the U.S. to go broke. We own the damn printing press, and we can print as much money as we want. In fact, the only reason for the U.S. to ever default on any its payments would be a desire for self-immolation. But a U.S. default would probably throw the world into a depression, so it would be worse than that. You'd end up blowing up the financial world as we know it. 

Which, of course, it exactly what the Republicans threatened to do in July of this year. 

(In a weird twist, there was a perfectly legal workaround. Normally, we add money to the federal budget by selling bonds, and that's what raising the debt ceiling does -- allow us to borrow more money. But an obscure statute -- 31 USC § 5112 -- allows the Secretary to "mint and issue platinum bullion coins and proof platinum coins ... as the Secretary, in the Secretary’s discretion, may prescribe from time to time. So Geitner could have printed a trillion dollar coin (or two), given it to Congress, and we could have gone on our merry way.)

But its probably worth a few minutes to address a third argument against a new stimulus plan, namely, that we can’t afford it.

While governments can’t really go broke, there are dangers to just printing cash willy-nilly. First, there is a danger that currency gets devalued. But in a recession, that’s not bug, that’s a feature. It’s exactly why Greece is screwed – hard – if it remains in the Euro.

If the dollar were to weaken, American exports would be cheaper, foreigners would buy more of our stuff and demand – all-important demand – would increase. Yes, European vacations would get more expensive for us, but American vacations would remain exactly the same price (and cheaper for Europeans), increasing demand – beautiful, shiny demand – for spending money in the States.

The second argument against borrowing more money is that borrowing would end up being inflationary. Well, here are some numbers about long-term inflation expectations, courtesy of the Federal Reserve Bank of Philadelphia.

The number in the middle column is the previous estimate. The number to the right is the revised estimate. It's actually gone down (for 2011-2015). Inflation is not a problem. (In fact, a bit more inflation might be a good thing.)

The third argument against borrowing is that the financing costs – meaning the interest payments (as opposed to repayment of principal) -- would be exorbitant and act as a drag on the economy. Fortunately, Paul Krugman ran the numbers.

As of [August 5, 2011], the US government could lock in 30-year bonds at a real interest rate of 1.25%. That means that a trillion dollars in extra debt would mean $12.5 billion a year in additional real interest payments.  

Meanwhile, the CBO estimates potential real GDP in 2021 at about $18 trillion in 2005 dollars, or around $19 trillion in 2011 dollars. 

Put these together, and they say that an extra trillion in borrowing adds something like 0.07% of GDP in future debt service costs. Yes, that zero belongs there.

It gets better. The real interest rate is has decreased by about 40% since Krugman wrote that column – it’s now only 0.79%. Adjusting Krugman’s numbers accordingly, that means that servicing an extra trillion in debt would cost about $7.5 billion in financing costs, and future debt servicing would be about 0.04%.

This is maybe the one good thing about what’s hitting the fan in Europe. When financial markets are under stress, you often see a “flight to safety,” where investors shed assets they now view as risky and head towards more conservative investments. And investors have decided that the US Treasuries are about the safest thing going. And that's not a bad idea -- we still have the largest GDP in the world, and 2011 GDP should be a bit above $15 trillion. (For a sense of scale, the global GDP for 2010 was about $63 trillion. We were responsible for about 23% of that.)

Here’s how weird things have gotten. If you invested $100,000 in the S&P 500 on January 1st, you would have lost about $10,000 by the end of September.

If, instead, you'd fled to safety and purchased $100,000 in Treasuries with maturities at least ten-years out, you would have made $28,000 in the same time period. That's a 28% return for investing in the world's safest product.

Right now, the world is desperate to buy Treasuries. The world really, really wants us to borrow their money. In fact, they’re so into us right now that for every $100 we borrow, they’d be willing to accept an effective return of a bit under 7 cents a month.

So can we afford an extra $7.5 billion in annual financing costs? Well, for the sake of comparison, the annual cost of providing air conditioning to the troops in Afghanistan and Iraq is about $20 billion.

Air conditioning.

We can do this.

Stimulus -- What? Another One? (Part Two -- The Reckoning)

Yesterday, we fielded a couple of questions from the Ochreous Man on the need for a second stimulus. One question, about the "job creators," we answered. The second we'll be tackling today.

Now – did the original stimulus fail?

Well, if you ask Douglas Holtz-Eakin, it sure did.

And who is Doug H-E? Well, he is a “former Congressional Budget Office director, former chief economic advisor to Sen. John McCain’s 2008 presidential campaign, and current president of the conservative American Action Forum.” In short, a pretty conservative dude.  And he made a splash when he created this graph to show that the stimulus didn’t work.

Holtz-Eakin said that:

The chart … shows actual GDP during 2009. It also shows what would have happened if the trajectory at the start of 2009 had continued the entire year (labeled “Continued Decline”) -- that is, the graphical version of “the economy was falling off a cliff.” The shaded area is the difference—the additional GDP from not continuing to decline—and totals $268 billion.

Stimulus tax cuts and spending in 2009 were roughly $260 billion. Thus, if one attributes all improvement in GDP to the stimulus—no role for the Fed, no role for mortgage relief programs, no role for worldwide economic improvement—then stimulus essentially broke even and provided no multiplier effects.

A key point here. Doug is NOT saying that the stimulus had no effect; he’s saying it had no multiplier effect. He does acknowledge that the $260 billion in stimulus had an effect, but that the effect was limited to $268 billion. So in no way should the stimulus be considered wasted money. As Doug says, the “stimulus essentially broke even.”

But Keynesians argued that the stimulus would have had a greater effect. In our sandwich shop example from yesterday, the stimulus was the new employer in town, but the multiplier effect – the spending of the new employees – had a multiplier effect which resulted in the hiring of an additional employee. And Holtz-Eakins said that didn’t happen.

Unfortunately for Doug H-E Fresh, he was working off of bad numbers. Those numbers were the best information at the time, but the Bureau of Economic Analysis revised those numbers in July of this year, and it showed that the economic situation was much, much worse.  An updated chart shows that the shaded area – “the additional GDP from not continuing to decline” – was more like $544 billion (not $268 billion).

The $260 billion in stimulus then had a multiplier effect of around 2.1, meaning that every $1 spent resulted in $2.10 in additional GDP.

Remember here that the methodology is unchanged. It’s the one recommended by a very prominent conservative economist. The only thing that has changed is the numbers getting plugged into that methodology. And those numbers show that the economy going into 2009 was not sliding into a recession – it was in free-fall.

In the second quarter of 2008, the economy grew by an annualized rate of just 1.3 percent. In the following quarter it contracted by 3.7 percent, and then by a whopping 8.9 percent in the last quarter of 2008 as President George W. Bush prepared to hand over the White House reins to President Obama.

By comparison, the original figures for the third and fourth quarters of 2008 were -0.5% and -3.8%. So the economy was cratering at more than twice the rate we thought it was.  That's huge.

So ...

if instead of assuming the economy would have contracted in each successive quarter at the same rate as it had in the fourth quarter of 2008, we assume that it continued dropping but at an increasing rate, as it had been during the last three quarters of 2008, then the success of the stimulus is even more pronounced, with a multiplier surpassing 5.

The first stimulus worked. It was just too small – just as Paul Krugman predicted shortly after the stimulus package was introduced. Now, Krugman gets called a lot of names, but we like him and, in this instance, he was demonstrably right.

But that’s not always the case. He also thought that a second stimulus would follow sometime later in 2009, and on that he was dead wrong.

Which is why, sadly, and two full years later, we have to do it now.