"Why does this matter for what we do next? One view of the current situation is that the core problem at the moment is that consumers are too frightened to spend and banks too hamstrung to lend. If that was your view, you might think that the goal of policy is to spur households back into borrowing and banks back into lending. . . . my reaction is that it's neither feasible nor desirable to return to the . . . the low saving and high leverage that we saw in 2005, [which] were an anomalous departure from the likely sustainable steady-state values, and there will be no road that leads back to those from here.
If that's the case, then resuming economic growth requires replacing spending on consumption and residential fixed investment with nonresidential investment and net exports. But charting a course for how to get there is profoundly challenging-- what firm would want to invest in the current environment, and which country is in a position to increase their purchases from us?
So Plan B, at least in the interim, would seem to be an increase in the fraction of GDP devoted to government investment."
Not being able to return to the status quo ante leaves macroeconomic policy with no easy, conventional path forward. It's an ugly world, as Nouriel Roubini points out:
"The latest macroeconomic news from the United States, other advanced economies and emerging markets confirm that the global economy will face a severe recession in 2009. In the United States, the recession started in December 2007, and it will last at least until December 2009 -- the longest and deepest U.S. recession since World War II. By the time it is over, the cumulative fall in gross domestic product could easily exceed 5 percent. . .
With a global recession and fall in aggregate demand a near certainty, deflation -- rather than inflation -- will become the main concern for policy-makers. Rising unemployment rates will cap wage and labor costs, and further falls in commodity prices -- already down 30 percent from their summer peaks -- will only add to these deflationary pressures.
Policy-makers will have to worry about a strange beast called "stag-deflation" -- a recessionary combination of economic stagnation and deflation. . . .
Likewise, with household consumption and business investment collapsing, governments will soon become the spenders of first and only resort, stimulating demand and rescuing banks, firms and households. The long-term consequences of the resulting surge in fiscal deficits are serious. If the deficits are monetized by central banks, inflation will follow the short-term deflationary pressures. If they are financed by debt, the long-term solvency of some governments may be at stake unless medium-term fiscal discipline is restored.
Nevertheless, in the short run, very aggressive monetary and fiscal policy actions -- both traditional and nontraditional -- must be undertaken to ensure that the inevitable stag-deflation of 2009 does not persist into 2010 and beyond."
Politically, the turnover among Senate Democrats brought about by Obama's cabinet appointments means that the 2010 mid-term elections have considerable potential to bring back the idiot Republicans back to power in short order, if they fall short thru timidity or other unwisdom.
As far as I can tell, the American People have, by a margin of 7% or so decided, after the unfortunate experiment with George W. Bush, to give liberalism (at least the weak tea version of centrist, plutocrat-friendly Democratic Party liberalism represented by Obama) its chance, but Plan B, being readied as an alternative by the Republicans is an ugly American fascism, where the poor, gay marriage, reality and logical thought are the enemy. Its a narrow window of opportunity, politically for what must be an economic policy of the long-term.
In that light, Free exchange at Economist.com labels James Hamilton's advice as Do Not Resusitate, and offers this sage observation:
"[Hamilton's observations] would seem to get at the heart of the various stimulus proposals. Some would have the government cut taxes, in an effort to boost private consumption or investment. As Mr Hamilton notes, however, we don't simply want to return consumption to previous, unsustainable levels. And savings rates are already quite high; new private saving would simpy add more money to the piles of reserves sitting limply in bank vaults, held there by terrified lenders. And then there's infrastructure spending.
It's interesting; much of the comparison of different stimulus options has focused on multipliers. But that variable alone leaves important variables out, namely, the state of the economy upon recovery. It could be poised for additional, and painful, adjustments of lingering imbalances. Or it could be buoyed by long-term investments made while borrowing is cheap. This seems like something worth considering."