Why I am worried

I believe that fiscal stimulus is both fundamentally sound and very important in the current economic situation that we are in. Monetary policy has largely run out of power, yes, there are certain things that the Federal Reserve can still do but they would most likely be too little too late. I understand why some people are skeptical about borrowing more money when that is a big part of what got us  into this mess in the first place but over the long run a prolonged recession or absence of growth would lead to greater losses in tax revenue then a large and effective stimulus.

Without getting into the details and starting to argue about different multipliers I also believe that the current stimulus is far from perfect (my perfect stimulus would pretty much look like the one described by Alice Rivlin) and that we have significant work to do on how to improve our chances for long term economic success. As I said recently the centerpiece of such a long term stimulus should be things that make America and all Americans smarter, something I will write more about in the future.

What really has me worried right now though is that Tim Geithner’s proposal for saving and restructuring the banking system is too timid and too unclear at a time when everyone is looking for the government to come up with a clear plan. The reason I am so worried about this is that the rest of the economy will be severely hampered until the banks recover as well. I’ve been worried about this for a while but a recent New York Times article on Japan’s crisis focused this worry even more:

A further lesson from Japan is that the bank rescue will determine the fate of the wider economy. While President Obama has prioritized his stimulus plan, no stimulus is likely to succeed unless the banking sector is repaired.

We have to come up with an effective solution for the banking problem before we can hope to get the rest of the economy going again, and we should think hard about what we need to do and what it will take, even if the solutions might sound politically difficult.

So far, the Obama administration’s plan avoids the hardest decisions, like nationalizing banks, wiping out shareholders or allowing banks to collapse under the weight of their own bad debts. In the end, Japan had to do all those things.

More to come…