Foreign Policy magazine has published a short interview with Martin Feldstein, conservative Keynesian economist, on the looming stimulus package. Excerpts:
MF: In the post-World War II period, recessions have been preceded by a combination of increased oil prices and high interest rates. And we certainly got a dose of both of those this time. The Fed raised the federal funds rate from 1 percent to 6 percent, and oil prices tripled…I wrote a piece in the Wall Street Journal a couple of years ago, asking: Why did the jump in oil prices (that we had then observed—from roughly $20 to $60 a barrel) not push the economy into recession? And I answered that by saying: because there was this surge in home-equity borrowing that allowed individuals to increase their consumption faster than their incomes. I concluded by saying that if energy prices continue to increase, we cannot count on that kind of offset from higher consumer spending financed by mortgage borrowing.
Fair enough. Consumer debt levels in the U.S. are at a level that requires higher asset values and/or higher future incomes. Asset values are not providing any support at the moment, and are actually working against this process.
The FP interviewer then offered a choice quote from a George Mason University economist in framing the following question:
FP: …Russell Roberts says the very idea of an economic stimulus package is “like taking a bucket of water from the deep end of a pool and dumping it into the shallow end.” As he put it, “If you can make the economy grow, why wait for bad times?” So, is the idea of a stimulus package just political theater, or do you expect it to really help?
MF: I do expect it to help, but let me be clear about why it’s not like moving water from one end of the pool to the other, or more accurately, why it is not a way of making the economy grow under all circumstances. If the economy is fully employed and growing at a normal pace, 3.5 percent, with unemployment under 5 percent and no expectation of a downturn, then aggregate demand is not the problem. Then, the only way to get the economy to grow more is to have more investment in capital equipment, people working harder, more innovation, and so on. And you can’t do that by simply giving money back to taxpayers to spend more. So, the “spend more” approach to increasing economic activity is not about long-term growth. What it’s about is offsetting the risk of an economic downturn.
Our take? The U.S. economy is still at or near full employment. An expected decline in aggregate (domestic) demand is not the problem, it’s a symptom. The underlying problem is over leveraged household balance sheets in the U.S. (in 1997-1998, it was over leveraged sovereign balance sheets in Asia and Russia). And as we’ve pointed out previously, the only way to support the timely repair of a balance sheet–and thus provide some comfort to risk averse credit markets–is through higher real cash flows over time. A one shot "stimulus" can’t accomplish that! But the long term investments that Feldstein describes above–which he seems to imply are not needed in the current crisis–would accomplish this goal. And for those kinds of investments to occur at a sufficient level, marginal returns on capital int he U.S. must be globally competitive. That’s something that corporate taxes, taxes on capital investment, trade barriers, and excessive regulation work directly against. If those wedges to productive activity are allowed to increase in 2009 and beyond, the U.S. economy is likely to start down a path similar to Japan’s since 1989.