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The Watering Down of the Stimulus Package

There are some things in economics that are debatable, and others that are not. Among the things that are not debatable is that GDP is equal to the sum of consumer spending (C), investment spending (I), government spending (G) and net exports (X-M). This is an accounting identity, just like on a balance sheet how assets have to equal the sum of liabilities and equity. So keep the equation GDP = C + I + G + X - M in mind in any commentary about the fiscal stimulus package. Memorize it -- it will be on test.

It is a mistake to think of this recession as just another garden variety recession. It is something that we have not seen since the 1930's in its basic character, but let us hope not in its severity. The jobs report on Friday showed that we are still accelerating to the downside.

Look at the chart below (fromhttp://globaleconomicanalysis.blogspot.com/) and it is clear that this is nasty already, and it is likely that the February report will be just as bad. One has to go back to the early 1980's recession to find anything of a similar magnitude, but that was a different animal. It was a deliberately engineered recession designed to break the back of surging inflation. This is a massive deleveraging of the economic system.

It is the Keynesian "paradox of thrift" writ large. Its dynamics are much more like what got us into the Great Depression. The only saving grace is that we now have some automatic stabilizers, the economy safety net that was not in place in the 1930's, as tattered as that net may be.

A good stimulus package is the only thing that has a chance to make this just a very nasty recession, rather than Great Depression II. Yes, the additional debt will be a long-term drag on the economy, but the government debt/GDP has been higher in the past, although not true for private debt/GDP. So there is still some room on the government balance sheet.

We have a big-time shortfall in aggregate demand, and C is not going to go up, it can't, and if C falls, then I will fall right behind it.