The Stimulus Trap

Krugman today:

Normally, then, we expect policy makers to respond to bad job numbers with a combination of patience and resolve. They should give existing policies time to work, but they should also consider making those policies stronger.

And that’s what the Obama administration should be doing right now with its fiscal stimulus. (It’s important to remember that the stimulus was necessary because the Fed, having cut rates all the way to zero, has run out of ammunition to fight this slump.) That is, policy makers should stay calm in the face of disappointing early results, recognizing that the plan will take time to deliver its full benefit. But they should also be prepared to add to the stimulus now that it’s clear that the first round wasn’t big enough.

Unfortunately, the politics of fiscal policy are very different from the politics of monetary policy. For the past 30 years, we’ve been told that government spending is bad, and conservative opposition to fiscal stimulus (which might make people think better of government) has been bitter and unrelenting even in the face of the worst slump since the Great Depression. Predictably, then, Republicans — and some Democrats — have treated any bad news as evidence of failure, rather than as a reason to make the policy stronger.

Hence the danger that the Obama administration will find itself caught in a political-economic trap, in which the very weakness of the economy undermines the administration’s ability to respond effectively.

This does seem to be the case. When officials try to find solace in only 565,000 new jobless claims, the credibility gap expands. And so the White House gets caught in between calling zero-growth, no-recovery policies the greatest thing since sliced bread, while constrained by the opposition from doing anything to fix the very real problems in the economy. Joe Biden and Barack Obama should defend a stimulus that has barely gone out to the public. A world without one would certainly be worse, and the last two quarters of the year should see much more money reaching the economy.

But we have to be honest about what's happening here. Foreclosures remain unsustainably high, and the efforts to shrink them have simply failed to this point because lenders stubbornly refuse to rework loan terms. The Administration is trying desperately to fix this, but with no success. And even if they could fix it, increased joblessness would supplant bad loans and keep foreclosures at a similar level. Unemployment's rise also begets reductions in consumer spending because nobody has any money. And more real estate meltdowns can be expected. In this environment, with the economy out of the woods for depression but hurtling toward a long period of stagnancy, of course further stimulus efforts should be readied.

But never let it be said that this White House isn't planning to help those in need. Not the people, mind you; the banks:

As the financial system tries to right itself after its near-collapse last fall, the Treasury Department has assembled a team to examine what could yet bring it down and has identified several trouble spots that could threaten the still-fragile lending industry.

Informally known as Plan C, the internal project is focused on vexing problems such as the distressed commercial real estate markets, the high rate of delinquencies among homeowners, and the struggles of community and regional banks, said government sources familiar with the effort.

Part of the mission is assessing which firms are the most vulnerable and trying to decipher what assets these companies hold and whether they pose a danger to the wider financial system. Plan C is a small-scale, relatively informal approach to a problem the administration hopes to address in the long term by empowering the Federal Reserve to oversee systemic risk.

They take care of their own.