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Popular Economics Weekly

Nobelist and New York Times columnist Paul Krugman recently wrote about “zombie” economics coming back from the grave to haunt us. By that, he meant a version of Adam Smith’s classical, free market economics that advocated less regulation and lower taxes that was in vogue in the 1980s. Their mantra was “Government is the problem”.

It was labeled ‘trickle-down’ economics as the ticket to greater prosperity for all because it advocated tax breaks to the wealthiest while allowing financial markets to regulate themselves.

Dr. Krugman lamented the fact that even though its principles had long since been discredited—only a few prospered, while it meant greater debt for government, and the majority whose incomes didn’t rise—its proponents were using its arguments to attempt to discredit the various stimulus plans, as well as health care reform.

The zombie economists maintained that cutting taxes always created jobs, forgetting that it depended on whose taxes were cut. When it was the investor class, then it usually resulted in an oversupply of goods and services that tended to create the various asset bubbles–such as housing. Unless the majority of consumers’ incomes were also boosted, there would be no one to buy the products.

That is why the various stimulus plans accentuate direct job creation more than tax cuts and cash rebates. Tax rebates provide a temporary stimulus but peter out when the money is gone. Putting the stimulus monies into various public projects-such as high-speed rail transport—creates not only jobs, but new industries in the better-paying high tech sector for the longer term.

The Cash for Clunkers is another example. By encouraging consumers to buy high-mileage cars, it nudges the auto industry and its affiliates towards energy conservation and lower pollution, as well as creating more jobs.

The stimulus monies were designed to feed into the economy over the next 2 years, once the financial markets stabilized. And so the just released minutes of the Federal Reserve’s latest Open Market Committee meeting point to continued concern that economic growth will take at least 2 years to recover. They are in no hurry to increase interest rates for that reason.

That’s a good thing for real estate values, in particular, not to speak of consumer debt loads, which have now fallen to 2005 levels. Low rates are spurring the real estate recovery, with fixed interest rates up to $729,750 now at or below 5 percent with a 1 point origination fee. The June Case-Shiller home price index increased for the first time in a year.

What about the federal debt? It is currently $9 trillion and on track to become $12 trillion by the end of 2009. That is approximately 80 percent of our Gross Domestic Product. That is high but nowhere near the record of 120 percent set in WWII, and it took that amount of government spending to get us out of the Great Depression.

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This is important, because without the government stimulus spending we could be in a full-blown recession. Interest rates would not be this low and job losses would be much more serious. So though the government debt is troublesome, we won’t be able to pay any of it back without a sustained economic recovery, which means when the private sector is willing again to expand.

Harlan Green © 2009