Given the gridlock in Washington, the quick response by Congress and the White House on a stimulus package is heartening. Yet, without taking away credit where credit is due, a stimulus package may prove to be a stopgap that does little to change the economic fundamentals. The conventional wisdom on the economy is that the subprime crisis and its ramifications for housing and credit markets is the cause of our current woes.
To be sure, these dramatic turns have been the immediate precursors of a weakening economy. But even before the current credit crisis, there were signs that the world's largest economy was courting trouble. We were consuming more than we were producing, and ignoring experts' predictions that the economy could not forever live on borrowed money. No one knew exactly what would trigger a correction, but a correction was inevitable.
Many American families and the federal government have been spending more than their incomes. Households were able to do this because credit, including housing credit, was cheap, easily available and seemingly endless.
In normal times, the demand for this credit would have raised its price, and higher interest rates would have choked off some of the demand. But foreigners were able to provide an almost limitless supply of excess funds acquired through selling us everything from oil to electronics. The result: we locked arm-in-arm with our trading partners in a co-dependent dance.
From this perspective, a recession may be needed to curb consumer appetites, remind people about the need to save for a rainy day and bring the nation’s spending more in line with production. If incomes drop during a recession so will our consumption, especially our proclivity to import more goods from abroad.
The depreciating dollar may have the same effect, but the falling currency also spurs inflation as imports rise in price, and thus cannot bear the full weight of the needed adjustment.
Like many Americans addicted to credit, the federal government is also living beyond its means. After running a surplus in the late 1990s, the federal government has been accumulating debt ever since. That deficit spending will accelerate as the baby boomers begin to retire this year and health care costs, almost half of which are paid for by government, continue to rise faster than the economy. No presidential candidate has addressed this issue in a serious way. But if nothing is done, we will simply be creating fertile ground for another round of bad news on the economy.
So, yes, warding off a short-term recession now with rebate checks, business incentives, and extended unemployment insurance is the right answer to the immediate problem and does illustrate how the branches of government can coalesce when necessary.
Ideally, however, we should pay for any stimulus package by cutting spending or raising taxes once the recession is predicted to be over. That would insure that this temporary fix didn't add to the debt. But even should this prove impossible, something must be done to deal with the very large and unsustainable deficits now projected over the coming decades.
By all means, let's have some fiscal stimulus. But let's not lose sight of how we got to where we are and what we need to do to prevent such vulnerabilities in the future.