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.

Stimulus -- What? Another One?

Yes, another one.

The biggest problem facing America right now is a screamingly high unemployment rate (9.0%, for the seasonally adjusted U3 – the most commonly reported figure, and 16.2% for the seasonally adjusted U6, which includes under-employed individuals and those who have given up on looking for work). This means there are about 14 million folk without jobs, and about 24 million folk who want more work but can’t find it. (The total civilian workforce is about 150 million.)

But unemployment isn’t just a crisis for those who've lost their jobs. It’s also an incredible burden on government finances. If the U3 unemployment rate were at 4.5% as it was during 1998 (it went as low as 4.0% in 2000, Clinton’s last year in office), then 7 million Americans would be off the dole AND paying taxes.

So raising employment rates ends up being a two-fer: we save on outlays to support the unemployed, and we get to tax their income as well. And, since being unemployed, especially for longer periods of time, is often very stressful (or worse), it is, at the end of the day, a three-fer.

So – how do we get these folks back to work? You, sir, the rather ochreous fellow in the back – do you have something you’d like to say.

More than two years after the ‘stimulus’ was enacted the American people are still asking the question, ‘where are the jobs?’ It’s time to close the book on the failed ‘stimulus’ era in Washington, and start working together to remove the government barriers holding back robust private-sector job creation and long-term economic growth. 

Speaker of the House John Boehner

Excellent question, sir. You’ve stated the two most popular objections to a second stimulas package. The first is that the original stimulus didn’t work. The second is that the only way out of this mess to help the ballyhooed “job creators” do what they do best – create jobs.

Let’s take the second point first.

When an employer hires an extra worker, there is no question that the number of people on his payroll has increased. But hiring is very different from creating a new job in the society at large. Absent increased demand, that employer will have added to his company – but without affecting the number of unemployed at all.

Suppose you live in a town with one, crappy sandwich stop. You know you can run a better sandwich shop, so you start one up. And – as you guessed – you succeed. In fact, you do so well that you’ve got to hire yet another sandwich maker to handle all of your new business. You’ve now created one job – for your company.

The success of your sandwich shop, though, has come at the expense of your competitor. From a capitalist perspective, there’s nothing wrong with that. In fact, it’s a good thing, as people are getting more utility (in this case, the enjoyment of sandwiches) than they had before. But from the perspective of the owner of the other shop, it pretty much sucks. It sucks even harder for the sandwich maker he had to lay off – a good guy, nice to work with, always showed up on time. But without demand, that owner has to cut back, and the sandwich maker has to go.

So the crappy sandwich shop has lost one employee, and you’ve taken one on. The net employment effect to the town is 0.

Now imagine that a new employer shows up in town, and starts hiring folk. Now, the number of people who can afford to eat out at sandwich shops has increased. And most of them like your sandwiches, which mean you have to hire another sandwich maker. But this time, the crappy sandwich shop doesn’t have to fire anybody. And the net employment effect is now +1.

But you, as the sandwich shop owner, can’t really take credit for that job. You’re running a fine shop, but the key difference has been an increase in demand – which is due to the new employer! That’s the guy who should get credit, because not only has he hired people for his own company, but the spending of his employees has resulted in another employer – you – having to go and hire an additional employee

In the real world, that new employer is the federal government. When it engages in a stimulus program, it is adding demand to the economic system. And it’s that additional demand which gets people off the dole and back working and paying taxes.

Again, there’s nothing wrong, and a bunch right, when an employer adds his payroll. But hiring someone is fundamentally different from actually creating a job and reducing unemployment in society at large.

We'll tackle Speaker Boehner's second question tomorrow.