Fix the Recession – Then Fix the Budget Deficits

Dr. Errington Thompson

by Errington C. Thompson, MD

Over the last two years, I wrote and read a lot about economics. What happens in a recession? A lot of things, obviously, but the end result is the loss of jobs. Here’s an example of how a recession develops, first published by Joan and Richard Sweeney in Journal of Money, Credit and Banking, 1977.

Let’s say approximately 150 couples get together and decide they will babysit for each other when necessary. They come up with a system that is fair for everyone: they will use coupons, each one worth one hour of babysitting; every couple that joins the co-op is given a certain number of coupons; and every couple who leaves the co-op must turn in their coupons. Therefore, the currency is stable, and no couple starts out with an advantage.

Several couples that are extremely frugal and somewhat
homebodies start to accumulate coupons. Meanwhile, other couples who go
out frequently deplete their coupon supply. They look for opportunities
to babysit, but with several couples staying at home, these
opportunities are hard to find. This leads more and more couples to
stay home so they will accumulate coupons rather than further
diminishing their supply. Fewer and fewer coupons circulate: as coupons
become more and more scarce, and babysitting opportunities become
extremely rare, the babysitting co-op goes right into a recession.

The problem — the recession — faced by this co-op was caused by
the imbalance between too much supply (people wanting to babysit) and
not enough demand (nobody wanting to go out). How do you fix it? You
might pass a law requiring couples to go out a certain number of times
per month. This would force people to spend their coupons and prevent
hoarding. That would be one solution.

Another solution would be to increase the supply. If every
couple has an increased supply of coupons, and knows there’s an ample
supply out there, there’s no reason to hoard the ones they have. So
more couples start to go out, coupons start circulating, and the crisis
is resolved.

This is the solution that economists settled on a long time ago;
they realized that the only way to end a recession is to spend your way
out of it, the way we did in 1992 and again in 2001. And that has to
happen before you balance the budget; if you try to do it the other way
around, there would be no economy to stimulate. If everyone —
individuals as well as the government — just tightens their belts to
hoard what money they have, well, that’s how recessions get started in
the first place.

Now, back to the real world. At the beginning of 2009 the Obama
administration was facing rising unemployment, increased foreclosure
rates on home mortgages, and a GDP that was falling or stagnant —
problems that some thought could turn into a depression if there wasn’t
quick action. Economists said that somewhere between three and five
percent stimulus was necessary get the economy moving again.

Our Gross Domestic Product (GDP) is worth somewhere over $14.2
trillion, so five percent would be $700.1 billion. Under the Bush
administration, the Federal Reserve had already infused a small amount
of cash (think of it as a mini-stimulus plan) into the system. That
rebate plan of $152 billion (the Economic Stimulus Act of 2008) was
somewhere around one percent of the GDP, and there’s very little
evidence that it did anything to turn the economy around.

So Obama and his economic advisers decided on a second stimulus
package. The question is how big should the stimulus package have been?
Congress and the administration settled on $800 billion. Congress would
not authorize more than that, mainly for political reasons: we had just
bailed out the banks; we had just bought up toxic assets; it felt as if
the U.S. Treasury was hemorrhaging money.

Is it working, a year later? Slowly but surely, yes. And we have
to be patient. One of the reasons the Great Depression lasted so long
was because deficit hawks hounded President Roosevelt as soon as it
looked like the economy was turning around. He tried to balance the
budget too soon, prolonging the Depression by several years. So, when
you hear the so-called deficit hawks complaining about government
spending, remember: there is no better time for the government to spend
money then right now.

Turning the economy around takes time and knowledge. Isn’t it
nice to have a thoughtful president who took his time, read the
literature and listened to experts, and then acted?