Thursday, August 06, 2009

Why unemployment, and not the stimulus, is helping the economy

In this NYTimes piece, the Obama administration makes its case that its stimulus is what's keeping the economy from shrinking further. This is why economics is not, and should not pretend to be a science. So much has happened in the past 18 months, how can you really separate correlation from causation? It's easy to dismiss some patent drivel though:
The signs of the stimulus are there,” said Allen L. Sinai, chief economist at Decision Economics, a forecasting firm in New York. “Government — federal, state and local — is helping take the economy from recession to recovery. I think it’s the primary contributor.”
Federal Govt has helped some, but State and Local have not. Certainly, California's budget cuts in no way can be considered "stimulative", and the rest of the nation is just California writ small. Let's look at the other Government efforts that may or may not be having an effect (positive or negative):
For one thing, Mr. Obama’s stimulus program was only one component of a broader effort to combat the financial crisis. The Federal Reserve printed vast amounts of additional money, creating a raft of borrowing programs for financial institutions and businesses. It is in the process of buying up $1.25 trillion worth of mortgage-backed securities, a move that has pushed down mortgage costs for homeowners and new homebuyers. Meanwhile, the Federal Deposit Insurance Corporation has further subsidized lower borrowing costs for Wall Street firms and banks by offering federal guarantees on the bonds they issue.
Certainly the backstops have helped enrich the financial industry--NIMs have risen dramatically--but how does a better capitalized financial industry help the broader economy if not through cheaper credit (which we do not have)? And isn't credit rationed by ability to repay? It certainly isn't reserve requirements.

If you look at the actual numbers, it's clear that the biggest, most dramatic changes are 1) the expansion of the Federal balance sheet, and change in its composition, and 2) the increase in Federal debt. The former was driven by positive action taken by the Fed and Treasury to add more Govt money in a first loss position ahead of FDIC. Warren Mosler first made this point, and I think he is quite right: having a second branch of Government put Government money in front of another branch of Government already having Government money does not seem like the stuff that recoveries are made of. That leads us to the increase in Federal debt, or paid in equity, as unemployment (automatic stabilizers) lowers tax revenue and increases Government spending thanks to welfare benefits. This directly puts a floor under private sector credit collapse by funding the paid-in equity that all private sector balance sheets rest on.

So, a "stimulus" program that has yet to start, a rearrangement of financial assets, or an increase in private sector saving driven by unemployment, and set up by a Government 80 years ago, now running on autopilot? What do you think stopped the fall?


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