More Fiscal Stimulus is Needed to Reverse Economic Decline

In
February the Congress approved $787 billion of federal spending, in
order keep the economy from sinking into a deeper recession. However it
is increasingly clear that this is not enough, and a third stimulus
(the first was a small stimulus package early last year) will be
necessary.

About $584 billion of the stimulus
package will be spent over the next two years, in order keep the
economy from sinking into a deeper recession. This sounds like a lot of
money, but it is only about two percent of Gross Domestic Product (GDP)
over the next two years. Our economy shrank at an annual rate of 6.3
percent in the fourth quarter of last year; economists surveyed by the
Wall Street Journal project negative 1.4 percent for 2009, with
recovery beginning in the second half. However these forecasts have
been over-optimistic in the past -- most economists missed the housing
bubble and the disastrous impacts of its inevitable collapse.

In short, we really don't know where the bottom of the recession is, or
whether a prolonged period of high unemployment and weak growth will
follow. There has been a lot of emphasis on curing the ills of the
financial system, and this is surely necessary for a sustained recovery
to take hold. However it is not sufficient. Even if the U.S. Treasury's
latest plan were to restore solvency to the entire financial system --
and this seems very unlikely -- we would still be facing a serious
recession in the real economy. Even solvent banks are not going to
increase lending if there are no additional credit-worthy borrowers
seeking loans.

The latest data on home prices reinforces this point. The decline in
home prices is still accelerating, with the 20-city Case-Shiller index
falling at an annual rate of 26.5 percent over the last quarter. Home
prices have further to fall to get back to their pre-bubble trend
levels, and they could even overshoot on the down side: people who lose
equity in their homes when prices fall cannot afford a down payment
(now raised to 20 percent) for a new home when they have to move, and
rising unemployment and foreclosures add to the oversupply of housing.

The global economic outlook is also worsening, with the OECD now
forecasting a phenomenal 2.75 GDP percent decline worldwide. Although
the United States is fortunate in this respect to export only about 11
percent of GDP, shrinking global demand and an overvalued dollar do not
offer much hope for trade to boost the U.S. recovery.

The household savings rate collapsed to zero in 2007, from an average
of 8 percent in the post World-War II era. As savings recover to more
normal levels, it means that consumption, which is about 70 percent of
the economy, must fall. This can also further discourage investment and
add to the cycle of declining output and employment, as well as the
fear and pessimism that exacerbates it.

My colleague Dean Baker has put forth a plan for the government to
provide a tax credit to employers for health care and also to increase
employees' paid time off - in the form of reduced hours, additional
vacation, sick leave, or other days off. This has the advantage of
injecting money very quickly into the economy with minimal bureaucracy
or waste. If these credits cause employers to reduce average hours per
worker by just three percent, this would add 4.2 million jobs at the
same level of output.

With the collapse of private spending, it is clearly up to the
government to rescue the real economy, and ideological prejudices must
be swept aside. It is time for our government to consider some fresh
ideas that can be implemented quickly.

This op-ed was distributed by McClatchy Tribune Information Services