Krugman on what to do

by: Exile on Ericsson St.

Sun Nov 30, 2008 at 00:32:37 AM EST

Now, the United States tried a fiscal stimulus in early 2008; both the Bush administration and congressional Democrats touted it as a plan to "jump-start" the economy. The actual results were, however, disappointing, for two reasons. First, the stimulus was too small, accounting for only about 1 percent of GDP. The next one should be much bigger, say, as much as 4 percent of GDP. Second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent. The next plan should focus on sustaining and expanding government spending-sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

Four percent of GDP is about 520 billion dollars.

Krugman also recommends recapitalization of banks via the purchase of equity (as opposed to the purchase of troubled assets):

My guess is that the recapitalization will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control-in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. Just to be clear, this isn't a long-term goal, a matter of seizing the economy's commanding heights: finance should be reprivatized as soon as it's safe to do so, just as Sweden put banking back in the private sector after its big bailout in the early Nineties. But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what's necessary out of fear that acting to save the financial system is somehow "socialist."

As readers may have gathered, I believe not only that we're living in a new era of depression economics, but also that John Maynard Keynes-the economist who made sense of the Great Depression-is now more relevant than ever. Keynes concluded his masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: "Soon or late, it is ideas, not vested interests, which are dangerous for good or evil."

The great danger here is that economic know nothings -- supply-siders, Washington Post editorial writers, and so on -- inject red herrings and ignorance into what is developing into a broad consensus about this economic crisis (namely, that it is dire and that averting catastrophe needs to take precedence over things like federal budget deficits and so-called moral hazards).

It's also worth noting that the federal situation may be quite different than the state one: a compelling case can be made (as Robert has in some recent posts), that the state faces true structural issues -- in particular, the possibility of huge medium-to-long term losses in tax revenue from the New York-based finance industry -- that may require some degree of budget cuts.  On the other hand, severe cuts in things like SUNY could have disastrous effects; here one might help that federal aid makes it possible to avoid drastic NYS measures.