Back to the Stimulus and Deficits Reality

A lot of people believe that if we could just get the banks to quite hoarding and start lending then we'll be off to the races again. While fixing the banks is important, vital, it is not the silver bullet "solution". Don't forget that a large part of the financial industry was obliterated - the "shadow banking system", which isn't coming back soon. That was a huge chunk of lending that will have to be replaced by something new. Also, and most important, GDP growth via borrowed money was yesterday's paradigm, and a big reason we're in this mess.

Another problem we're going to have is the output gap, the difference between potential GDP and actual GDP. The idea behind the stimulus package is for the government to (borrow and) spend and make up the difference, mitigating the ravages of a declining GDP. This may pose a serious problem if what is really in store is a demand re balance to a lower level - as Michael Pettis describes:

There is a real need for an adjustment in consumption in the US, and I don’t think it makes sense for the US to attempt to replace excess household consumption with excess government consumption. One way or the other the US, along with China and most other countries that have contributed to one side or the other of the global imbalances, is going to have to accept a demand contraction.

Optimism Abounds at the White House - Tim Duy sees the economy in free fall and doesn't think the stimulus is big enough: "I grow increasingly fearful that the pace of economic deterioration will leave the US economy in a much deeper hole than this Administration expected, swallowing the stimulus package."


Wolf Versus Pettis on US Stimulus, Fiscal Deficit - Martin Wolf comes to two conclusions: the stimulus needs to be much bigger; and the government will need to run huge deficits for a very long time.