What is the case for not providing more additional stimulus spending to boost economic growth? Harvard Econ Prof Gregory Mankiw, former Bush White House economic advisor, gave this rather bizarre prediction for the future behavior of employers on his Blog. It seems that more stimulus spending creates more debt, ergo raises the prospect of higher taxes.
So, “businesses may be reluctant to invest in an economy that they expect to be distorted by historically unprecedented levels of taxation in the future,” he says. “The more the government borrows, the higher taxes will need to go, the more distorted the future economy will be, and the less attractive is investment today.”
Yes, it is true that debt levels figure into both investment and spending decisions, but no one has been able to quantify how much. Consumers, for instance, are still paying down debt in record amounts. So much so that the personal savings rate has risen to 4 percent, from zero in the past decade. But consumer spending has also ramped up to almost 4 percent, which means incomes are increasing. Therefore, it doesn’t look like anyone is yet worried about higher future taxes.
Consumer credit contracted a sharp $9.1 billion in May with April revised to show an even more severe $14.9 billion contraction, as we said last week. Revolving credit contracted $7.4 billion and contracted $8.3 billion in April. Non-revolving credit shows a $1.8 billion contraction in May on top of a $6.5 billion contraction in April. Neither category is likely to show much improvement in June given indications from retail sales and last week's soft unit vehicle sales.
So, what’s going on—are consumers retrenching? That might be part of the story. Outstanding consumer credit can decline either due to consumers paying balances down or because banks and finance companies are charging off bad credit. But the charge offs are actually a positive for consumer spending—more discretionary income is freed. The big picture is that the consumer is still cautious, says Econoday.
So why would such a reputable economist as Dr. Mankiw advance an unproved hypothesis? Some of it has to do with discredited economic theories that say our economy is a zero-sum game. When the government spends money, it takes away investment from the private sector. Households seem to operate that way, for instance. There is only so much money to go around, right?
But what happens when businesses hoard their cash, as they are doing now? The $1.8 trillion being held by the S&P 500 largest corporations are not being used—either in R&D that would create future products and services, studies show, or increasing their production capacity.
And so economic activity stagnates. Money sits at basically zero interest, earning zero returns—unless government steps in to borrow that money to directly create jobs, as it has been doing in green technologies, or to retain jobs with infrastructure investments.
That is the real debate. Conservatives want government to shrink spending, in order to shrink the amount of debt. This is because too much debt devalues the debts of creditors, which mostly reside on Wall Street. Whereas Keynesian economists believe in stimulating demand by putting more money into consumers’ hands that will stimulate more revenues going into the coffers of both government and private industry.
Year on year, personal income growth for May posted at 1.6 percent, easing from 2.6 percent in April. It became positive again in July 2009, at the end of the Great Recession. Year-ago headline PCE inflation edged down to 1.9 percent from 2.0 percent. Year-ago core PCE inflation firmed down to 1.3 percent from 1.2 percent in April. Falling prices might be the reason consumers remain cautious buyers.
But overall, the consumer sector is slowly gaining strength in terms of spending power, thanks in large part to government stimulus programs. Purchases have been a little erratic due to off and on auto and home buying incentives. But the consumer sector took one step forward in May, helping the recovery continue.
So what is the lesson from “give ‘em hell, Harry” that we asked last week? Econ Professor and columnist Paul Krugman thinks most who oppose government stimulus oppose government in general. President Truman believed in the New Deal, and the need for government support during tough economic times.
Those who worry about too much debt are worrying about the wrong debt. Stimulus spending creates short term debt that will come down when economic activity picks up. But longer term debt that will be carried by future generations comes from entitlements like social security and Medicare, which are projected to grow exponentially with retiring baby boomers. How to pay for those entitlements is a decision which should be faced by the present generation, rather than passed on to their children and grandchildren.
Harlan Green © 2010
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