For some time here I’ve been saying that those who believe that a fiscal stimulus is just what our economy needs to get it back on track are thinking too small for such a stimulus to be effective. Paul Krugman agrees:
So what kinds of numbers are we talking about? GDP next year will be about $15 trillion, so 1% of GDP is $150 billion. The natural rate of unemployment is, say, 5% — maybe lower. Given Okun’s law, every excess point of unemployment above 5 means a 2% output gap.
Right now, we’re at 6.5% unemployment and a 3% output gap – but those numbers are heading higher fast. Goldman predicts 8.5% unemployment, meaning a 7% output gap. That sounds reasonable to me.
So we need a fiscal stimulus big enough to close a 7% output gap. Remember, if the stimulus is too big, it does much less harm than if it’s too small. What’s the multiplier? Better, we hope, than on the early-2008 package. But you’d be hard pressed to argue for an overall multiplier as high as 2.
When I put all this together, I conclude that the stimulus package should be at least 4% of GDP, or $600 billion.
That’s twice what the unreliable rumor says. So if there’s any truth to the rumor, my advice to the powers that be (or more accurately will be in a couple of months) is to think hard – you really, really don’t want to lowball this.
I also think that the sort of stimulus is just as important as the size of the stimulus. We need to stimulate business activity not consumer spending. Propping up consumer spending will serve more to stimulate the Chinese economy than it will ours and they already plan a stimulus package of their own.
Paul Krugman’s related NYTimes column also points out that raising taxes offsets the stimulas.
I am having doubts that we actually know what is happening..it seems to me that so much is going on that we could make more mistakes by jumping into this so quickly, unless, unless we actually know the all the facts..I have seen so many theories about what to do and not to do..this is not making sense…is this a brush fire or is it a major wild fire and one that is just out of control?
From The Oil Drum: are we facing something like this?
REYKJAVIK, Iceland — The collapse came so fast it seemed unreal, impossible. One woman here compared it to being hit by a train. Another said she felt as if she were watching it through a window. Another said, “It feels like you’ve been put in a prison, and you don’t know what you did wrong.â€
http://www.theoildrum.com/node/4740#more
I’ll second infrastructure spending. This is actually something which should be done anyways, but since it is an economic slowdown – why not do it now?
As for the deficit and debt, keep in mind that we could push it further; the Japanese Debt to GDP, as pointed out by the CIA Factbook, is much higher than the US’s. Not that we should aim for that bar, but we could still do some serious deficit spending, particularly if we have to do it anyways at some point (and if it will create jobs and economic growth).