The Mini Depression and the Maximum-Strength Remedy

This is not the Great Depression of the 1930s, but nor is it turning out to be merely a bad recession of the kind we’ve experienced periodically over the last half century. Call it a Mini Depression. The employment report last Friday shows job losses accelerating, along with the number of Americans working part time who’d rather be and need to be working full time. Retail sales have fallen off a cliff. Stock prices continue to drop. General Motors is on the brink of bankruptcy. The rate of home foreclosures is mounting.

When Barack Obama takes office in January, he will inherit a mess. (Because I’m an informal economic adviser, I should remind anyone who reads this blog that it reflects only my thoughts and therefore should not be attributed to him or to anyone else advising him.) What to do?

First, understand that the main problem right now is not the supply of credit. Yes, Wall Street is paralyzed at the moment because the bursting of the housing and other asset bubbles means that lenders are fearful that creditors won’t repay loans. But even if credit were flowing, those loans wouldn’t save jobs. Businesses want to borrow now only to remain solvent and keep their creditors at bay. If they fail to do so, and creditors push them into reorganization under bankruptcy, they’ll cut their payrolls, to be sure. But they’re already cutting their payrolls. It’s far from clear they’d cut more jobs under bankruptcy reorganization than they’re already cutting under pressure to avoid bankruptcy and remain solvent.

This means bailing out Wall Street or the auto industry or the insurance industry or the housing industry may at most help satisfy creditors for a time and put off the day of reckoning, but industry bailouts won’t reverse the downward cycle of job losses.

The real problem is on the demand side of the economy.

Consumers won’t or can’t borrow because they’re at the end of their ropes. Their incomes are dropping (one of the most sobering statistics in Friday’s jobs report was the continued erosion of real median earnings), they’re deeply in debt, and they’re afraid of losing their jobs.

Introductory economic courses explain that aggregate demand is made up of four things, expressed as C+I+G+exports. C is consumers. Consumers are cutting back on everything other than necessities. Because their spending accounts for 70 percent of the nation’s economic activity and is the flywheel for the rest of the economy, the precipitous drop in consumer spending is causing the rest of the economy to shut down.

I is investment. Absent consumer spending, businesses are not going to invest.

Exports won’t help much because the of the rest of the world is sliding into deep recession, too. (And as foreigners — as well as Americans — put their savings in dollars for safe keeping, the value of the dollar will likely continue to rise relative to other currencies. That, in turn, makes everything we might sell to the rest of the world more expensive.)

That leaves G, which, of course, is government. Government is the spender of last resort. Government spending lifted America out of the Great Depression. It may be the only instrument we have for lifting America out of the Mini Depression. Even Fed Chair Ben Bernanke is now calling for a sizable government stimulus. He knows that monetary policy won’t work if there’s inadequate demand.

So the crucial questions become (1) how much will the government have to spend to get the economy back on track? and (2) what sort of spending will have the biggest impact on jobs and incomes?

The answer to the first question is “a lot.” Given the magnitude of the mess and the amount of underutilized capacity in the economy– people who are or will soon be unemployed, those who are underemployed, factories shuttered, offices empty, trucks and containers idled — government may have to spend $600 or $700 billion next year to reverse the downward cycle we’re in.

The answer to the second question is mostly “infrastructure” — repairing roads and bridges, levees and ports; investing in light rail, electrical grids, new sources of energy, more energy conservation. Even conservative economists like Harvard’s Martin Feldstein are calling for government to stimulate the economy through infrastructure spending. Infrastructure projects like these pack a double-whammy: they create lots of jobs, and they make the economy work better in the future. (Important qualification: To do this correctly and avoid pork, the federal government will need to have a capital budget that lists infrastructure projects in order of priority of public need.)

Government should also spend on health care and child care. These expenditures are also double whammies: they, too, create lots of jobs, and they fulfill vital public needs.

Expect two sorts of arguments against this. The first will come from fiscal hawks who claim that the government is already spending way too much. Even without a new stimulus package, next year’s budget deficit could run over a trillion dollars, given the amounts to be spent bailing out Wall Street and perhaps the auto industry, and providing extended unemployment insurance and other measures to help those in direct need. The hawks will argue that the nation can’t afford giant deficits, especially when baby boomers are only a few years away from retiring and claiming Social Security and Medicare.

They’re wrong. Government spending that puts people back to work and invests in the future productivity of the nation is exactly what the economy needs right now. Deficit numbers themselves have no significance. The pertinent issue is how much underutilized capacity exists in the economy. When there’s lots of idle capacity, deficit spending is entirely appropriate, as John Maynard Keynes taught us. Moving the economy to fuller capacity will of itself shrink future deficits.

The second argument will come from conservative supply-siders who will call for income-tax cuts rather than spending increases. They’ll claim that individuals with more money in their pockets will get the economy moving again more readily than can government. They’re wrong, for three reasons. First, income-tax cuts go mainly to upper-income people who tend to save rather than spend. Most Americans pay more in payroll taxes than in income taxes. Second, even if a rebate could be fashioned, people tend to use those extra dollars to pay off their debts rather than buy new goods and services, as we witnessed a few months ago when the government sent out rebate checks. Third, even when individuals purchase goods and services, those purchases tend not to generate as many American jobs as government spending on the same total scale because much of what consumers buy comes from abroad.

Fiscal hawks and conservative supply siders notwithstanding, a major stimulus is in order. Government is the spender of last resort, and the nation is coming close to its last resort.

Originally published on November 9, 2008 at Robert Reich’s blog and reproduced here with the author’s permission.

19 Responses to "The Mini Depression and the Maximum-Strength Remedy"

  1. devils advocate   November 9, 2008 at 3:31 pm

    why not bolster consumer confidence/concumption with:replace the unemployment compensation benefit with”guaranteed annual wage”?

    • devils advocate   November 9, 2008 at 3:34 pm

      10,000,000 unemployed x $35,000 (annual av wage) = $350 billionvery doableif all the unemployed receive their full “guaranteed annual wage”with time on their hands, they’ll resume shopping

      • devils advocate   November 9, 2008 at 3:37 pm

        in fact, this will be their new full-time job: to go shoppingwhy be chinsy?won’t the rest of the world be happy to be back working for our shoppers?

      • Guest   November 9, 2008 at 4:59 pm

        This is the best argument yet for passing a new law that revokes TARP. Do it fast before the money is stolen, er, used for bonuses.

  2. Oppose The International Jewish Plutocracy   November 9, 2008 at 4:07 pm

    The macroeconomic-machinations and mass-manipulations of international-finance Jews like Reich, Summers, Bernanke, Greenspan, Kohn, and many others found in the New York City-London-Tel Aviv Axis is what led the world in to this Mini Depression…and now we expect these same people to get us out of it?

    • Anonymous   November 9, 2008 at 7:59 pm

      someone please delete this anti-Semitic comment.

      • Guest   November 10, 2008 at 6:35 am

        yes, please delete it

    • Guest   November 9, 2008 at 8:28 pm

      I think Reich is a Catholic, not a Jew. He has produced a large number of children, typical of Catholic families. As a rule, Jews do not produce large families.

    • international jewry   November 15, 2008 at 5:57 am

      this guy just wants truck nutz; probably an upset Palin voter.

  3. Guest   November 9, 2008 at 5:02 pm

    Religion is whatever it is. I think Reich is correct on the merits.The alternatives are to hyperinflate, or a Jubilee and cancellation of debts. I see no other alternatives. I think we need fiscal and monetary stimulus. Debts must be monetized to a considerable extent, and infrastructure programs are needed. Both very fast.

  4. bcdogs   November 9, 2008 at 6:18 pm

    Won’t infrastructure projects largely employ those that are here from south of the border versus US citizens….quite a few of these dollars are sent home (again south of the border…), not paid payroll taxes on etc. Many are sending money home so that there family can join them and spending just enough to live, the rest goes home or is spent in the shadow economy, garage sales, flea markets, etc…I suppose putting the money in the hands of the business doing the contracting/hiring would have some impact.I don’t know about the rest of the country, but most of the construction work done in these parts is done by those south of the border. Companies subcontract things out etc., to avoid proper documentation…I really think infrastructure projects will further fuel the xenophobia that already exists regarding folks that are here from another country trying to make a better life for their family, by bringing them here or simply sending it home to help. As US citizens cannot find jobs and are losing homes, etc.., it’s going to cause a lot of anger and resentment. I also don’t think this will help all the white collar workers losing jobs, are they suddenly going to become blue collar workers? I don’t think that a lot of former MS, GS, WB, workers are going to be lining up to get their hands dirty…and I don’t see how infrastructure projects can circularly cause these white collar jobs to rise…That said, I really think we need projects like this, I just think it needs to be handled in a certain way…and have some pretty grave doubts that it will be…perhaps an Obama administration will do a better job…I know if Bush were going to be handling it, it would be hello Halliburton and no bid contracts… the devil is always in the details…

  5. Yves   November 9, 2008 at 7:23 pm

    All this is not so simple:1- The additional demand would expand imports and widen the current account deficit, which on the contrary needs to be reduced. So a keynesian approach would really work only in unison with the other big players, i.e, Europe, China, and Japan at least.2- The fiscal deficit could increase much more than most analysts have been expecting: all the bail-outs plus a big and sustained fiscal boost, in a recessive environment producing less income to the government… I can foresee deficits for the next 2 years to the tune of $ 2 trillion /year. Then would the foreign lenders continue to finance the US so obligingly?In fact the real issue in this crisis is that the major imbalance of the US overconsuming / Asia + oil exporters oversaving must be addressed. This is the basic macroeconomic problem these days: how to shift demand from the US to Asia? it must be done in the end, but I suspect it will take many years; years of protracted recession.Please someone comment on this view. Thanks.

    • devils advocate   November 10, 2008 at 7:04 am

      Thank you Yves for this very thought-through commentary(and your articles as well)————USA/world is buying less from China + its own citizens in China are buying lessReal Estate, construction, stocks are down and factories are closing =less Chinese domestic consumption (just like the USA/world)therefore China is trying to stimulate/spendChina just announced it would spend over 2009-2010 almost $600 billion US on “infrastructure”(just like the USA/world)the $$$ will go into businesses and into Jobs/to rehire those getting laid off and those on farmshowever, the Chinese consumer is famous/notorious for saving+ the US dollar must weaken before China/world will buy USA goodswill the US explosion of debt weaken the dollar enough?-I agree that we will approach $2 trillion of debt per year for 2009-2010but the rest of the world is exploding their debt as wellso the debt explosion is going to be ignoredyes, they will buy US debtbut how can they weaken the US dollar enough?and control the currencies?this, I believe is the crux of the new international order to be worked outand after we invest trillions in infrastructure, what follows?what good are new roads and bridges, when our factories are vacant?this, I believe is the real issue of the new New Deal to be worked outa modern factory needs 5 years from drawing board to erectionat the end of the first 4 years of the new New Deal, what then?how can our factories produce competively to the Chinese?American wages and benefits are 30-50x higher than the Chinesedoes anyone see light at the end of the tunnel?Please someone – anyone – who can be optimistic please comment

  6. chris hagel   November 10, 2008 at 8:24 am

    Robert…your statement…”Most Americans pay more in payroll taxes than in income taxes”…’Income Taxes’ are merely ‘payroll taxes’, with the exception of FICA and Social-Security. The source of one’s ‘income’ is their ‘payroll’, is it not? If 70% of GDP growth is consumer-oriented, then it appears that the more direct effect of a tax-cut is actually related to a payroll-tax cut. Can you please clarify your observation?

    • JR in WV   November 15, 2008 at 10:24 am

      “Payroll tax” in economics are taxes everyone pays at the same rate, and that are dedicated to specific programs. They include social security deductions, unemployment deduction, etc.Income taxes in economic discussions are only similar to payroll taxes in that they are deducted from your total payment. They differ in that they are used to fund the government’s budget as a whole, rather than being directed to a specific program like social security, etc.

  7. Guest   November 14, 2008 at 7:08 am

    I think Reich’s plan is spot on. It makes much more sense than anything else I’ve heard to date. Invest $$ now in things that will make us stronger. Its like a company that’s in trouble, they don’t up their debt, if they are smart, they reorg, take the hit now to make themselves stronger for the future. I also think allowing inefficient and badly run companies to reorg under bankruptcy laws is much more efficient than bailing them out,which will only spend good money after bad. Now the question is, how do we get this done? Ideas ?

  8. CSF   November 14, 2008 at 7:24 am


  9. Guest   November 14, 2008 at 12:14 pm

    Keynes, plus Davidson and D’Arista…

  10. Econophile   November 14, 2008 at 2:06 pm

    I can’t believe anyone still listens to Reich. He passes himself off as an economist when he’s not. I doubt the guy ever picked up an Econ 101 textbook. He has no idea what causes business cycles: especially this one. He reiterates Keynesian solutions that have never worked and never will. The Great Depression was not ended by government spending. Government spending was one of the causes of the Depressions. Now we see the Fed and Treasury making the same mistakes that Hoover and Roosevelt made in the 1930s. They turned a nasty recession (about the same as prior crashes and recessions) and turned it into a decade long depression. Government spending is just a command-type economic decision to take money out the economy and spend it on feel-good projects. The government doesn’t create jobs; they just transfer wealth from producers to people who don’t produce. Another form of welfare. Consumer spending won’t take us out of this recession. Until overvalued assets reach their bottom, and bad companies go out of business, the economy won’t pick up and banks won’t lend. All this Hooverism and New Deal stuff will only make things worse, as history has shown. He is reiterating the classic mistakes that have been pointed out over and over to be harmful, not helpful.