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February 06, 2009

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a point of view published on thehill.com :

There are very few economists who really buy into Keynesian theory anymore. Instead, the idea of “rational expectations” has taken its place. The difference between the two approaches is essential to understanding why Obama’s stimulus package won’t work.

Keynes felt that people would react automatically to a few dollars in their hands. Consumers would run out and buy new products, and businessmen, seeing the uptick in sales, would rush to open new plants and hire new workers who would, in turn, generate more demand.


But that’s not the real world. In reality, consumers, knowing there are hard times ahead, save any money they get either by salting it away or by paying down their debts and bills. That’s why the personal saving rate in the last quarter of 2008 was the highest in six years and spending on residential construction was down 22 percent over the past year. And the savings rate rose from 2.8 percent in November 2008 to 3.6 percent in December as the storm clouds grew grayer.
And, in the real world, banks hang onto their money for fear of making bad loans, no matter how many bailouts or stimulus packages Washington passes.

According to the Federal Reserve Board of St. Louis, the Fed is now holding upwards of $1.7 trillion for American banks, more than twice what it had in its vaults at the start of 2008. How did the Fed get the money? Congress voted the Troubled Asset Relief Program (TARP) package of bailout funds. The Fed purchased bank assets to get liquidity onto their balance sheets. What did the banks do with the money? They gave it right back to the Fed to hold in its vaults. They didn’t lend it out. They didn’t use it to stimulate the economy. They are using it for a nest egg to tap when times improve. Just like the theory of rational expectations says they would.

If banks, suddenly awash in capital, don’t decide all is fine and rush to lend money; and consumers, given a tax cut or a pay raise, don’t rush to buy a flat-screen TV, then what good will the stimulus package do?

Not much. It is not until there is evidence that the underlying problem — massive personal and corporate debt — is being solved that any degree of confidence will return. And, without confidence, the rational expectation theory means people sit on their money.

But the package will do a whole lot of harm by piling up capital that people won’t spend, banks won’t lend and businesses won’t invest. When confidence rises and the money comes out of hiding, watch out for the massive inflationary pressures all that extra cash will unleash.

Obama’s stimulus package won’t stimulate much except inflation down the road, which will, in turn, mean the onset of another round of high interest rates and renewed recession to check the inflation.

Republicans should defeat the stimulus package and then negotiate a much smaller bill that emphasizes tax cuts and avoids the pork-barrel feeding frenzy Obama has unleashed. You can see the stimulus package rotting away before our very eyes.

People are turning against it as they see the things on which government will now be spending money, just as they turned against Clinton’s more modest $35 billion stimulus package in 1993. Republicans should stay away in droves. On this issue, they can recapture something they have lost over the past eight years — the mantra of less spending and smaller government.


Best to ignore the media on this. The people are not turning against the stimulus bill but get turned off by the arguing. It is too bad the whole Congress didnt' get turned over in the last election as it is a roadblock to anything new. Until the old die off, the new cannot try new things. All of what you said about what we need in infrastructure is right. How do people build bridges with a tax rebate? It's nuts and it is only digging our hole deeper. The media is providing the shovel. Read the papers, read the bills, ignore the pundits from either side. They are making their millions by telling us what to think and they will give any story equal weight even if it has no real traction. It's their job.

Read both sides too (actual articles of the proposals, the percentages, who'd get the money) as it is helpful for everything but blood pressure. It's hard to believe how differently we see this and without any chance right now to understand the other remotely. It serves someone's purposes to keep it that way.

tucson, what you shared makes quite a bit of sense. People, and banks, indeed are sitting on their cash. This won't change until they have more confidence that the economy is getting better -- that more acorns will be grown on the money tree and they don't have to keep all that they've saved up.

But I don't see how tax cuts are the answer. People will just save the extra money in their paycheck, or a rebate check, rather than spending it, which won't help things. With government controlling most of the stimulus money (60% or so is spending, the rest tax cuts) we know it will be spent.

Not all wisely or well, that's a given. The key thing, though, is restoring confidence. If people see the government taking bold action to get the economy moving again, that perception alone will help get the economy moving again.

I understand why Republicans are talking trash about the stimulus bill. That's politics. But it doesn't help restore confidence to have them keep saying, "It'll never work; things will just get worse."

The political scientist Francis Fukuyama, says that there is a natural economic cycle, like a swinging pendulum, that takes us from extreme interventionism to extreme free market practice and then back again. Clearly the pendulum is now swinging back toward more direct governmental control and less reliance on free market forces. Perhaps it is like swinging from capitalism toward socialism.

If we believe this to be true then the current economic slump or recession was not caused by any objective cause but rather simply triggered by the subprime mortgage losses which caused a snowballing loss of consumer confidence in the markets. In addition our loss of confidence was further eroded by the politicians and the media and even by each of us frightening each other like a bunch of wary hedgehogs.

Thus ended our roaring buy now and pay later economy, whereby consumption was financed by credit cards and house owners saved zero because they reckoned that the rising property market was doing their saving for them. Thus our high-spending lifestyle went down the drain as it was replaced by a new lifestyle of caution and thrift. Thus household savings began to recover, and a gap begin to grow between supply and demand, and naturally people got laid off and corporate investment is frightened off.

The eminent Polish economist Leszek Balcerovicz says that the authors of fiscal stimulus packages take people for Pavlov's dogs who react predictably to stimulus signals because they live by conditioned reflexes rather than by logical reasoning.

So if this is true then is it all that bad to waste about a trillion dollars to save people some misery while repairing our infrastructure and keeping the wary hedgehogs from more misery and even civil disobedience if we can avoid a long recession through reckless government spending?
If so then I say go for it!

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