Supply-sider extraordinaire Alan Reynolds says that the verdict over the Obama stimulus is simple. Stimulus is Snake-oil. It never works. And it didn't work in the 1930s, despite the testimony of two generations of Keynesians.
Guess what, he writes. The so-called FDR stimulus wasn't anything like the Obama stimulus.
The budget deficit peaked at 5.9 percent of GDP in 1934, falling to 4 percent in 1935. Today, the Congressional Budget Office adjusts such deficits for the impact of recession, which would convert the deficits of 1934-35 into cyclically adjusted surpluses. That is, the US economy grew by 10.9 percent in 1934 and 8.9 percent in 1935 without any "fiscal stimulus."
Today's budget deficit is somewhere north of 9 percent of GDP.
The argument over Keynesian stimulus depends on what you think is the problem when there's a downturn in the economy.
The Keynesians argue that the problem in a recession is a lack of aggregate demand. Pump out some stimulus and you'll revive demand and restore the economy to the status quo ante.
The opposing argument, advanced by the Austrian School of economics, is that the problem in a recession is the collapse of the capital investments made in the previous boom. A recession is the period of adjustment during which the bad investments made in the previous unsustainable boom are liquidated.
Actually, other peoples' bad investments aren't that much of a problem unless they were financed with borrowed money. Why is that? Simple. If you make a bad investment with your own money, you don't have to liquidate and sell at a loss. If you make a bad investment with borrowed money, there is hell to pay.
Suppose you save money for 20 years and then go out and buy a house for cash at the top of a boom. House prices go down 20 percent and you lose your job. Now you have lost 20 percent of your investment. You have a problem. But you suck it in and carry on. You take a lower-paying job, of course, but that's ok because you don't have a big mortgage.
Suppose you go out and buy a house with 10 percent down at the top of a boom. House prices go down 20 percent and you lose your job. Now you have lost all your investment. Plus you have defaulted on your mortgage and lost your house. Plus you (and millions of others) have reneged on your promises and put the bank underwater. Taking a lower-paying job won't help because you need the income from the high-paying job to make the mortgage payments. Now you are broke and the bank has a problem. Not just the bank but the whole financial system.
Hey, this finance business ain't that hard.
There is nothing magical about Keynesian stimulus. It is just the way that governments always act. Rulers like to concentrate all the resources of society on one big thing. Maybe it is a war. Maybe it is a mega-project to go to the moon, or to give everyone a low-money-down mortgage, or health insurance. Either way, the ruler commandeers the financial system and orders everyone to pull together for the Big Push. It works for a year or two until everyone has to get back to ordinary life: making a living and paying for the kids' education. Then we are all screwed.
The problem the US faces is not a lack of aggregate demand, whatever that means. The problem is that millions of people got in way over their head in the housing market. They borrowed money that they couldn't afford to repay unless house prices went up forever. When people can't repay their debts it puts the whole financial system at risk. It doesn't matter whether the millions of people did this because of greedy bankers (the Democratic line) or stupid government housing subsidies (the Republican line).
The question is: how do we go forward?
The simple answer for us today that we can't go forward until we have liquidated the bad real-estate investments made in the great housing boom.
And it doesn't seem that a big stimulus is going to do a thing to solve that problem.
Mr. President: your turn.