Simple thoughts about stimulus

by on January 28, 2008 at 6:45 am in Economics | Permalink

If every American saved the rebate and invested it in equities, we might be (ever so slightly) better off.  Government can borrow at a low interest rate for us.  Of course we’re being told to spend the money.

Most fundamentally, more aggregate demand is not the answer because insufficient aggregate demand was not the problem in the first place.  Just as a social framing effect (and lots of fraud) led subprime loans to be perceived as
"not very risky," right now social framing effects — call them collective fear — are causing lower asset prices, some degree of
credit constipation, and higher risk premia.  The economy is undergoing a sectoral shift toward less risky assets and that can bring an economic downturn.  The shift itself is costly, it brings thorny coordination problems (e.g., sudden insolvencies, overturning of credit expectations), and lower-yielding assets also mean less wealth.  Lack of liquidity simply is not the fundamental problem. 

Arguably there is a secondary negative aggregate demand shock at work, mostly because asset prices are lower from the sectoral shift.  Monetary policy should offset this secondary effect, to keep things from getting worse, but still monetary policy won’t and indeed can’t set things right again.   

More speculatively, you might argue that boosting aggregate demand may convince people to postpone their adjustments to the sectoral shift, thereby making the coordination problems last longer.  Maybe, but I won’t push that on you for lack of evidence.  Another speculative argument is that boosting aggregate demand can push us all back into optimistic expectations but that is unlikely. 

The bottom line: Our expectations from the Fed or a stimulus plan should be very modest, even if the boosts to aggregate demand are done perfectly.

lxm January 28, 2008 at 11:29 am

I have a question. Here’s a bunch of charts re: the rise in consumer debt: http://www.huffingtonpost.com/hale-stewart/the-illusion-of-the-bush-_b_83197.html?view=print

They look pretty ominous to me, but I am not an economist. The question is if consumers can not go into debt as they have over the last several years, what will drive the economy. Are we headed for a cliff?

Jarick January 28, 2008 at 11:51 am

I’ve thought that a major reason for the economic downturn is supply shock, not declining aggregate demand. I’m not sure where the housing market falls, but the sharp rise in oil prices, energy, and food (none of which are covered in the CPI) would have the effect of stalling GDP yet maintaining high levels of inflation. So it would seem that at best an economic stimulus plan would push GDP slightly but really worsen inflation.

The other thing that bothers me is the implications this has for consumer debt. It seems to me Americans have been overspending, not underspending, and a result is massive debt. A one-time tax rebate would be more conducive to debt repayment or savings, especially in the face of a recession, but do we really want to encourage more of this behavior?

Then again, I’ve only a lowly BA in economics, so my understanding is primitive.

CJS January 28, 2008 at 1:19 pm

What to folks think about the proposed feature of the stimulus that would raise the limit on conforming mortgages that could be bought by Freddie and Fannie (and then securitized) to up to $730,000? See here: http://www.erate.com/fannie_mae_freddie_mac_mortgage_limits.htm

DanC January 28, 2008 at 1:59 pm

Some cities, Cleveland, Detroit, Buffalo etc need help dealing with weak local economies and the growing negative externalities from foreclosures. Nothing in this stimulus plan will help them. If you are looking at foreclosure these rebates will hardly save you. If your neighbor forecloses that is a bigger blow to your net worth then the value of this rebate.

Housing prices in some markets remain too high (compared to local incomes). I was in Chicago recently were I saw a home in a solid slightly upper middle class suburb listed at $775,000. If you use the old rule of thumb that a house should equal 2.5 times your annual income, you need an income of about $310,000 to buy this house. The house was OK but not that special. 15 years ago homes on that block sold for about $200,000. Something is wrong with this picture.

I remember being in Miami looking to buy a condo. I asked myself three questions: how many people in this country can afford a $1,000,000 condo, how many of those would want to invest in such a condo, and why are so many builders rushing to build them?

Until current housing stocks decline, new home construction will not increase for most of the country.

The tax credits (and lower interest rates) might move some extra cars.

Retailers and restaurants might see a slight bump.

Some parts of the country are in serious trouble. But for the most part the economy is OK. Rural farmers are seeing an increase in incomes that dwarfs the tax rebates.

jon January 28, 2008 at 4:39 pm

Foreclosures could possibly (would likely?) lower the property value of surrounding, non-foreclosed homes.

DanC January 28, 2008 at 5:21 pm

From Wiki
In economics, an externality is an impact (positive or negative) on any party not involved in a given economic transaction

The transaction between the lender and the foreclosed homeowner impacts the surrounding community who were not part of the transaction. Estimates vary but a 10% decline in home value, for homes near a foreclosed home, seems to be an average estimate.

david foster January 28, 2008 at 6:16 pm

There’s another part of the stimulus package, which has gotten much less attention–the expensing/accelerated depreciation changes for business investment. This might have some positive impact: the problem I see, though, is that a lot of plant & equipment investment takes a lot longer than a year to implement. If CSX railroad decides to take advantage of the incentive by buying 100 new locomotives, they will likely find that all of the locomotive plants are fully booked for the year already.

DanC January 28, 2008 at 8:23 pm

To Jarick

The negative impact of foreclosures in a community are true even in boom times. I will grant that a down market accelerates the process. Look at Detroit, Cleveland or Chicago – communities with increasing foreclosures you will see decreasing values. Why, because foreclosures are a signal of problems in the community and sometimes communities reach tipping points that start a slide from which recovery is almost impossible. When you buy in a community you are buying a set of attributes. Even if you are religious in the upkeep of your property, if your neighbor’s houses are all turning into pits, you will see declining value. Were homes overvalued. Sure. But high foreclosure rates, especially where even the lenders walk away, destroys communities. A few hundred such homes can destroy the value in thousands of homes in a community. You get a race to the bottom.

To Andy

I suggest you take an intro class in economics.

andy January 29, 2008 at 5:05 am

DanC: I did. The price is a result of my action and my action is based on my preferences. Because you consider change of price as an externality, I have to conclude that you consider a change of someones mind as a result of my action as an externality.

For example: When Michal Jackson says he drinks Coca-cola, it is a “negative externality” imposed upon Pepsi-Cola. If you consider “externality” as something bad that should be compensated by the government, what action should the government take in this example?

I suggest that such definition of “impact” is meaningless. More meaningful is that the rights of other people not involved in economic transaction are infringed upon. In many cases the rights cannot be clearly defined, the definition should somehow encompass these cases as well.

The examples would be: polluting the water/air while not being prosecuted by the government (e.g. current car owners) is an externality – it definitely infringes upon rights of others but it is impractical to try to stop individual polluters.

On the other hand: change of price of a house because the people in neighberhood decided to move out is not an externality because you would not find any infringement however hard you tried.

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