Why we need more government spending

The other day I was talking with a co-worker about the dire state of our economy and the President Obama's stimulus plan. She's does not follow politics obsessively (yes, I do). She lives in a very depressed state and has been involuntarily under-employed for quite a while. She's not poor, but she is certainly among the economically anxious. And she voted for our new President and wishes him well.

But she was not sure about his stimulus plan. The conversation went something like this:

Me: I sure hope the Republicans get off their high horses and let Congress pass the President's economic plan.

My friend: Well, I don't know. Maybe it's time we all learned that we can't spend more than we earn. I mean, people took on mortgages that they could not possibly pay. And they bought everything they wanted whenver they wanted it on credit cards. I know people who are never going to get out of debt.

I'm just not sure the government should be encouraging people to keep spending more than they really have ...

I knew I should be able to explain why, at this moment in time, we should fear more that people will stop spending, than that this country will go back to unthinking consumption. But I wasn't able to be convincing.

For those of us who have always worked at not carrying big debts, who don't run up credit cards, who have tried to save for the future, it is hard to understand why the government should now be trying to get people spending again. Didn't greed coupled with individual irresponsibility run the economy off a cliff in the first place?

Well , yes, but most economists agree that the danger now is that people and businesses will become fearful, save (hoard) what cash they have, and our economy will fall into the stuck place they call a "deflation." Here's Paul Krugman:

... it’s quite clear that we’re in serious paradox of thrift territory here. Or perhaps more accurately, we’re in a paradox of debt.

What does he mean? Fortunately, Matt Yglesias today took a crack at putting this in understandable terms. He says, just suppose

... it’s not just me looking to build a bigger cushion by cutting back on spending, it’s a whole bunch of people looking around and feeling nervous and deciding to cut back. Well, with all that cutting back there’s a lot less stuff flying off the shelves. So retailers start laying off workers (who need to reduce spending and whose friends start feeling nervous and reducing their own spending) and discounting the merchandise. Maybe the sales are so impressive that everyone changes their mind, decides that the bargains are too good to pass up, and goes and buys a bunch of stuff rather than increasing savings. If so, the economy just had a minor hiccup and life goes on. But maybe the accelerating wave of discounts just makes people feel more nervous. ...

The economy needs someone to decide to borrow some money and start a new firm that employs these newly unemployed people. But with the volume of consumption going down so rapidly, nobody’s really in the mood to start a new business. And existing businesses are busy scaling back production, not interested in borrowing money to ramp it up. The result of this is an overall fall in the average level of income. And that means that even with the share of income being saved going up, the actual level of savings can be going down and we can truly end up in the toilet.

We're living in a time when individual decisions not to spend, added together, can and will add to the tailspin the economy is already suffering. Those rational, responsible decisions will lead to more people being laid off, less reason for businesses to invest or expand, and more people who need help from the safety net.

And in such a time, most individuals won't be able to risk spending more -- they'd be irresponsible, as my friend said. But some push to get the economy working again has to come from somewhere and only the government can afford it today. The bet is that a growing economy tomorrow, spurred by spending today, will enable the government in the future to pay down the debt it takes on now. The U.S, government has always been able to grow back into solvency; lenders, even today, still seem to trust that it will be able to pay its bills in the future.

So if we are to have a hope of a prosperous future for our society, we need stimulus spending now. In fact a lot of economists think what is likely to come out of Congress is not irresponsibly large -- it is irresponsibly small. Maybe someday I'll learn enough to be able to talk about that coherently.