Obama's Stimulus Failure
The economy badly needs stimulus. The collapse of the housing bubble caused us to lose more than $1.2tn in annual demand. Residential construction collapsed when the bubble burst, falling by more than 4 percentage points of GDP, which translates into approximately $600bn a year in lost annual demand.
The collapse of the bubble also led to the destruction of close to $8tn of bubble-generated housing equity. The wealth effect of this equity on consumption generated close to $500bn in annual consumption demand. This also was lost when the bubble burst.
In addition, the collapse of a bubble in non-residential real estate cost another $100bn or so in annual demand. Finally, the lost tax revenue from the collapse of the housing market and the resulting fallout have forced cuts of close to $150bn a year on state and local governments.
In total, the economy has lost close to $1.3tn in annual demand as a result of the collapse of the housing bubble. This explains the economy's weak growth and high unemployment. There is no simple way to replace this demand.
We can gather together a coven of market-worshipping Republicans and sacrifice all the workers and retirees we want, it still will not replace the demand gap. We can love the private sector as much as we want and it still will not make firms go out and invest and hire when they don't see demand for their products.
That might be a painful truth for government-haters to take, but it is reality. Businesses don't invest when they don't think it is profitable and it won't be profitable as long as they don't see the demand.
This means that we need the government to generate demand to boost the economy. That was the point of President Obama's stimulus. Of course it was nowhere near large enough, as his advisors told him at the time.
The package produced around $300bn a year in stimulus in 2009 and 2010. This was nowhere near large enough to offset the drop in demand from the housing crash, but it did create 2-3 million jobs.
If President Obama had been doing his job, he would have immediately begun pushing for more stimulus the day after the first one passed. He should have been straightforward with the American people and said that the stimulus approved by Congress was an important first step, but that the severity of the downturn was so great we would likely need more.
Instead of being honest with America, he started talking about the "green shoots of recovery" and said he was going to focus on the budget deficit. This was an error of unbelievable proportions. By raising the budget deficit front and centre, he backed himself into a corner from which it is almost impossible to now escape.
It was essential that Obama keep leading the charge on stimulus, explaining to the country the cause of the economy's weakness was a lack of demand. This story is counterintuitive, so it requires the voice of the president, along with many others, to constantly explain the logic to the country. People had to understand that we are poor because the country as a whole is spending too little to keep the workforce fully employed, not because the government is spending too much.
This is the context in which we are arguing over extending the reduction in the social security payroll tax for another two years. As stimulus, this is not an especially good measure. On a per-dollar basis, tax cuts will be much less effective, especially with people carrying so much debt, than direct spending. Furthermore, many of these tax dollars will go to better-off tax payers who are less willing to spend than moderate income families. The Making Work Pay tax credit was much better targeted.
Finally, there is zero reason that this tax cut should be tied to social security in any way. As it stands, the trust fund is held harmless because the lost tax revenue is reimbursed from general revenue. But why even raise this as a potential issue for social security; why not just give everyone a tax cut equal to 2 percent of their wages up to $110,000? The only reason to tie the tax cut to social security is if the intention is to raise issues about the social security tax at some future point.
The response of the Obama people to this complaint is that this is the only tax cut that the Republican Congress will approve and that we badly need the stimulus. The second claim is definitely true and the first one may well be also. But if that is the case, it only speaks to the incredible failure of this administration to define the agenda and speak honestly about the economy. It's not surprising that they don't have the political support for more effective stimulus when they abandoned the effort to make the case almost two years ago.