Stimulus or Depression?

Steven KyleCornell University

February 2009

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%

Christmas Spending Plans

Year Average Spending Percent Change

American Research Group Survey Nov10-13; 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– WW2 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