Obama's Bailout

THE STIMULUS

There are, broadly speaking, three things the federal government can do to address this kind of economic crisis.

First, the government can offer help to victims of the crisis, with the goal of diminishing the suffering. This help can take a number of forms, from expanding unemployment benefits to rewriting mortgage terms.

Second, the government can act to support the overall level of spending in the economy, either by spending money itself or by giving money to individuals or businesses and hoping that they'll spend it.

Third, the government can step in to rescue and sustain key institutions crippled by the crisis — especially banks, whose continuing ability to lend is crucial to the economy.

These aren't mutually exclusive categories: To an important extent, the government can do well by doing good, and vice versa. Helping the unemployed can prop up consumer spending, helping homeowners can strengthen the banks, and a stronger economy reduces the number of victims.

The Obama administration has moved on two of these fronts. But it hasn't moved enough on either and has so far balked at the third.

The best of the policies announced so far is the homeowner–relief package. To reduce foreclosures, the administration will offer reduced rates on millions of mortgage loans made by Fannie Mae and Freddie Mac, the government–sponsored (and, since they were nationalized last year, government–owned) lenders. It will also offer subsidies and guarantees to private lenders who restructure mortgages.

Overall, this plan should help large numbers of people. But the arithmetic of the situation suggests that it will make only a minor dent in the overall economic problem.

The stimulus bill that was signed into law on February 17th is a much bigger deal: $787billion in economic support, most of it over two years — a huge measure by normal standards. In addition to helping support the economy, the bill will do a lot to aid the slump's victims: increasing unemployment benefits, helping unemployed workers maintain their health insurance and assisting state governments in paying for Medicaid and education — which will in turn help them avoid painful cuts in services that tend to fall hardest on the most vulnerable members of society.

Yet impressive as the stimulus bill is by normal standards, it's smaller than many economists were recommending. In my own pre-inauguration letter to the president ("What Obama Must Do," RS 1070), I called for a stimulus of $800 billion in the first year alone — more than twice as large as Obama's plan, which amounts to less than $400 billion a year. Furthermore, a relatively large share of the plan — almost 40 percent — consists of tax cuts. And cutting taxes yields much less bang for the buck than government spending, because a substantial fraction of tax cuts will be saved rather than spent.

Here's one way to see the trouble with the stimulus: The Congressional Budget Office predicts an "output gap," the difference between what the economy could produce and what it will actually produce, of $2.9 trillion over the next three years. A $787billion stimulus just isn't big enough to bridge that large a gap; even when you account for indirect effects, such as the fact that higher employment will lead to higher consumer spending, we'll be lucky if the plan closes a third of the gap.

Or think of it in terms of jobs: The administration says that the stimulus will, at its peak late next year, create or save around 3.5 million jobs, which is nothing to sneeze at. But as of last January, the number of unemployed Americans had already risen by 4.1 million since the official start of the recession, and the economy was continuing to lose jobs at the rate of 600,000 a month. So while the bill will significantly reduce the eventual rise in unemployment, it won't even be enough to make up for the damage that has already happened, let alone the further damage to come.

Why wasn't the plan bigger, and why does it contain such a large proportion of tax cuts? Part of the explanation lies in the economics: Obama officials wanted public spending to focus on "shovel–ready" projects — that is, projects that could start employing workers and boosting the economy fairly quickly. But there is a limited supply of such projects: We can all think of major public investment projects that should be undertaken, but most of these would take years to get under way. As it is, more than half the "discretionary spending" in the bill (which means things like infrastructure projects) is expected to take place after September 2010.