Simon’s reaction to Obama’s speech last night is up at The New Republic.
I think Simon and I agree that the speech was strong on long-term issues, but did not shed much-needed light on how we can emerge from our short-term challenges. One way to position this is to say that if we really are facing a potential “lost decade,” then talking about the long term is a bit premature. Imagine ten years of zero real GDP growth as opposed to 2.5% real GDP growth (with population continue to grow at 1-1.5% or something like that). That would take decades to make up (if it is even possible) and could outweigh any well-meaning efforts to bolster our long-term government finances.
On the other hand, I’m a bit more positive than Simon, because I wasn’t expecting the details of the banking rescue plan in a major speech to the whole country, for both practical reasons (I don’t think they are ready yet) and political ones (Obama wants to keep some measure of distance from whatever Geithner does). If I have time later today I’ll say something about the long-term issues.
Update: Now it’s later. The main thing I liked about the Obama speech is that it reflected what I believe to be the true long-term economic priorities of the country. The day after Obama was elected, I listed what I think are our top four long-term challenges (economic and non-economic): global warming, terrorism and nuclear proliferation, retirement savings (both the insufficiency of retirement savings, and the fact that retiree benefits threaten to break the federal government’s balance sheet), and health care.
Obama’s speech yesterday was mainly about four things: energy, health care, education, and fiscal sustainability. That maps pretty closely to what I think our priorities should be. He was willing to say that these are urgent, serious problems. And when it comes to the government deficit and the national debt, he has chosen to forgo the gimmicks used in the past: not only keeping the Iraq War out of the budget, but also pretending that the AMT will not be fixed every year in the future.
Admitting you have a problem, and recognizing its magnitude, is a necessary, though not sufficient, step on the way to solving it.
Larry Summers made a convincing case yesterday that Congress should release the remaining $350bn of the TARP. It’s good to see the Obama team emphasizing themes beyond the fiscal stimulus, including banks and housing. Stronger governance and greater transparency are timely commitments for this program, and who can object to limits on executive compensation in today’s environment? Some Congressional debate makes sense and could be productive, but it’s hard to see this request being turned down.
Still, what exactly should the money be spent on? I’m tempted to say: housing, because this continues to be a major unresolved problem that looms over both consumers and their balance sheets. Unfortunately, however, the banks remain a greater priority. The latest developments for both Citigroup and Bank of America suggest the banking situation is (again) seen by insiders as more desperate than we outsiders wished to believe.
The next round of bank recapitalization (again) needs to be big and bold, for example along the lines we have been suggesting for some time (but I’ll take another comprehensive plan, if you have one, with strong expected taxpayer value). The problem today is that we just don’t know if any major bank is well capitalized; there are too many black boxes that may contain toxic assets. At best, this is a brake on the positive effects that should come from the fiscal stimulus. At worst, we still have a major system issue on our hands.
And there is no reason to think that $350bn is enough to handle this problem. The original $700bn was obviously an arbitrarily chosen number, and the money has been spent so far in a rather unplanned manner. What we do next should not be constrained by the fact that there is a check for $350bn waiting to be picked up. We should design a systematic recapitalization program, figure out what it will cost, and get on with it. My working assumption, based on the published analysis of the IMF regarding losses relative to private capital raising, is that $1trn – properly deployed – should do the trick.
Then we should get to work on housing (yes, this needs more money).
Update: Ben Bernanke seems to be thinking aloud along similar lines.
Most of the current discussion regarding the Obama Economic Plan focuses on whether the fiscal stimulus should be somewhat larger or smaller ($650-800bn seems the current range) and the composition between spending and tax cuts. President Obama stressed on Tuesday that trillion dollar deficits are here to stay for several years, and it looks like part of the arguing in the Senate will be about whether this is a good idea.
There is at least one key question currently missing from this debate. Is this Plan too much about a fiscal stimulus and too little about the other pieces that would help – and might even be essential – for a sustained recovery? The fiscal stimulus may be roughly the right size (and $100bn more or less is unlikely to make a critical difference), but perhaps we should also be looking for more detail on the following:
1. Recapitalizing banks. Their losses to date have not been replaced by new capital and it is currently not possible to issue new equity in the private markets. If you think we can get back to growth without fixing banks, check Japan’s record in the 1990s.
2. Directly addressing housing problems, including moving to limit foreclosures and reduce the forced sales that follow foreclosures. There is apparently some form of the Hubbard-Mayer proposal waiting in the wings, but we don’t know exactly what – and this matters, among other things, for thinking about the debt sustainability implications of the overall Plan.
3. Finding ways to push up inflation, presumably by being more aggressive with monetary policy. Deflation is looming – according to the financial markets, despite all of the Fed’s moves and recent statements, prices will fall or be flat over the next 3 to 5 years. This fall in inflation, from its previous expected level around 2 percent per year, constitutes a big transfer from borrowers/spenders to net lenders/savers. The contractionary effect is likely to outweigh any fiscal stimulus that is politically feasible or economically sound. (We have more detail on this point on WSJ.com today, linked here.)
So perhaps the issue is not the absolute size or composition of the fiscal stimulus, but rather the role of the fiscal stimulus relative to other parts of the Plan. Hopefully, it’s a more evenly weighted package, and just we haven’t yet seen the details. Still, it’s odd that the presence and general contours of these other important elements have not yet been clearly flagged.