Stimulus or Depression Steven Kyle Cornell University February

Stimulus or Depression? Steven Kyle Cornell University February 2009

Christmas Spending Plans Year Average Spending Percent Change 2008 $431 - 50% 2007 $859 - 5% 2006 $907 - 4% 2005 $942 - 6% 2004 $1, 004 + 3% 2003 $976 - 6% 2002 $1, 037 -1% 2001 $1, 052 + 9% 2000 $968 + 3% 1999 $939 + 1% 1998 $928 + 34% American Research Group Survey Nov 10 -13; Tel. Interview with 1, 100 Adults

What Will 2009 Look Like? • Still a way to go down in real estate – Commercial real estate just starting – House prices still need to fall • Stimulus won’t kick in right away – Only just now signed into law – Further lags after that • Monetary Policy all used up • Consumer Confidence still at rock bottom

Will it Turn Around? • IF we get a big enough stimulus then yes • Eventually, ratios will return to historical levels • See for example – Autos – Household debt

The Gap in Demand GDP = C + I + G + Net Exports C is down – People have rediscovered savings I is down – Why invest if nobody is buying? NX is down – The rest of the world is in recession also • That leaves only G able to expand • •

What Kind of Stimulus? • DO – Make it soon – Contribute directly to immediate spending • • Extend Unemployment Aid to state government Aid to already-in-the-pipeline projects Try to promote long run growth where possible

How Much? • Historical Context – WW 2 is what got us out of the Great Depression – Deficits ranged as high as 25% of GDP – That was likely more than enough but still, it was huge – Chinese just announced stimulus of 20% of GDP • Goldman Sachs estimate of current gap at around 10% of GDP • Too much less dangerous than too little

Pushing on Strings – Don’t think that tax cuts will necessarily be spent • Consumers saved a large part of last May’s stimulus check • What would YOU do with sudden influx of money? – Don’t imagine that incentives to lend = actual lending • Banks don’t want to lend for good reason

About those banks … • Throwing money will work – If we throw enough we WILL make them solvent • Buying toxic assets – The problem is at what price to buy them? • If at market price then problem isn’t solved • If above market price then we should get ownership • But nobody knows the right price because there is no market in these assets

Nationalize the Banks? • Pros – If we are shoveling more money than they are worth then we should get ownership – If we don’t get ownership then we are bailing out stockholders and managers – If we don’t inflict pain on managers why should they avoid doing it again? – Automatic mechanism to recoup bailout money – It has been done successfully before

Nationalize the banks? • Cons – Governments make poor bankers • But are they worse than the geniuses who brought us this mess? – Ohmygod it’s SOCIALISM • But only temporarily – Will sell them back later – Politics very difficult