A stimulus we can believe in

With the inauguration fanfare over and done with, the stimulus clock has started ticking. So as we’re getting back to business, I thought I should elaborate my kitchen-sink critique of Obama’s plan, to bring the point home and address some email commentary that was so misunderstood as to, well, hurt my feelings!

So the key problem I have with the “stimulus” package in its current form is that it confuses the distinction between a (true) stimulus and the implementation of a longer-term vision that the Obama administration may have for this country.

The former must be speedy and designed to have maximum impact, by addressing the root of the mess, while providing safety nets (e.g. unemployment/health benefits) for those who suffer while they suffer. The latter cannot (and should not) be speedy—it should be a meticulously thought plan, with a clear end-game and careful consideration of the broader measures needed to catalyze private participation in this vision, once financial conditions normalize.

As a result of this confusion, I fear we’ll be getting a “stimulus package” that is ever expanding in size (already up $50 billion in a week), piecemeal in addressing the root of the problem and, in parts, potentially wasteful.

Take financial-sector restructuring first. That’s priority no.1 for getting the economy back to its feet: You can’t talk about sustainable job creation and competitiveness, if American companies cannot finance their business plans with interest rates that make sense!

What’s the new administration’s end-game in this regard, how fast can it get there and how much will it cost?

I should say, the debate has been finally moving in the right direction (see for example the recent testimony by the Fed’s Donald Kohn). And, certainly, the wish list considered at the House is ambitious (though worrisome when it comes to potential conditions on bank lending).

But if you want to use $40-100 billion to stem foreclosures; and give money to every bank that asks for it, large, small, systemic or not; and bail out the automakers; and support new consumer lending by buying up asset-backed securities (ABS); and carve out the bad assets from banks to eliminate uncertainty over counterparty risk; and keep some money in case another bank goes bust… well, you should put a more realistic number to the “financial restructuring” component of the stimulus than the TARP’s $350 billion currently budgeted for. A number you should add to the rest of the stimulus being discussed. (And let us not forget the cost of the eventual resolution of the Fannie & Freddie quandary).

Else, it won’t be long before the second $350 billion is exhausted and the Summers/ Geithner(?) duo have to rush to Congress for yet another arduous approval process of “TARP, The Sequel”… with all the concomitant consequences for investor confidence and resumption of lending.

My preference would be for a forward-looking financial restructuring package that is bold in its size and honest in its trade-offs. Evidently, a clear communication of what’s needed to resolve our mess is critical for surpassing the admittedly difficult politics involved. But hey, Obama surely can!

Then consider all the proposed spending for a clean, efficient and American energy. A laudable vision no doubt. But one that would be best discussed outside the stimulus framework and, rather, in the context of a comprehensive set of reforms designed to align private sector incentives in this direction.

You can give research grants or loan guarantees for renewable energy projects for two years. But if the private sector lacks the incentives to take over the financing of these projects, the spending will be wasteful (unless the government is willing to keep up). And arguably, with oil prices as volatile as they’ve been, and currently at $35 a barrel, these incentives may well be lacking.

Mind you, I don’t feel qualified to make specific proposals in this area myself. All I’m saying is that spending on energy and the environment should not occur in haste, under the mantra of a stimulus package. Especially since, per the estimates of the CBO, the implementation of the discretionary part of the stimulus is likely to be very backloaded—meaning little truly “stimulative” effect in the near term. Such spending should therefore be considered in the context of a more comprehensive medium-term plan. Ditto for plans to spend on other competitiveness-enhancing areas such as science & technology.

Then we have the tax cuts. As I said in my earlier post, I actually think the proposed tax cuts might be a more effective “stimulative” than tax cuts usually are, if they are seen as part of a permanent plan to increase disposable income (as per Obama’s election promise). But still. I’d rather see any permanent tax cuts as part/a first stage of a broader reform of the tax code that improves incentives for saving and investment and simplifies compliance.

Importantly, I’d like to see how the Obama team plans to reconcile the economic challenges in the short-term with the fiscal challenge of the medium-term: The large fiscal deficits “for years to come” with a credible plan to repay them subsequently… in order to avoid building expectations for higher interest rates and inflation in the future… and especially in the face of a growth in entitlements (social security, Medicare/Medicaid) that already makes America’s fiscal position unsustainable.

So there you go.. the “medium” and the short of it. Let’s make that distinction clear and get the ball rolling.


Originally published at the Models & Agents blog and reproduced here with the author’s permission.