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How to End Our Financial Misery

A large-scale stimulus program is the only action that can possibly do the job.

The collapse on Wall Street is now decimating Main Street, Ocean Parkway, Mountain View Drive and I-80. Since January the economy has shed 760,000 jobs. In September alone, monthly mass layoff claims for unemployment insurance jumped by 34 percent. General Electric, General Motors, Chrysler, Yahoo! and Xerox have all announced major layoffs, along with the humbled financial titans Goldman Sachs and Bank of America. Fully one-quarter of all businesses in the United States are planning to cut payroll over the next year. State governments are facing a tax revenue shortfall of roughly $100 billion in the next fiscal year, 15 percent of their overall budgets. Because states have rules requiring balanced budgets, they are staring at major budget cuts and layoffs. The fact that the economy's overall gross domestic product (GDP) shrank between July and September -- the first such decline since the September 2001 terrorist attacks -- only confirms the realities on the ground facing workers, households, businesses and the public sector.

The recession is certainly here, so the question now is how to diminish its length and severity. A large-scale federal government stimulus program is the only action that can possibly do the job.

So far, our leaders in Washington have dithered. Treasury Secretary Henry Paulson and Federal Reserve chair Ben Bernanke continue improvising with financial rescue plans, committing eye-popping sums of money in the process. Paulson's original program for the Treasury to commit $700 billion in taxpayers' money to purchase "toxic" loans -- the mortgage-backed securities held by the private banks that are in default or arrears -- was at least partially shelved in favor of direct government purchases of major ownership stakes in the banks. But neither of Paulson's strategies has thus far helped to stabilize the situation, with global stock and currency markets gyrating wildly and investors dumping risky business loans in favor of safe Treasury bonds. The crisis has even hit the previously staid world of money market mutual funds, where the fainthearted once could park their savings safely in exchange for low returns. Money market fund holders have been panic-selling since mid-September, dumping $500 billion worth of these accounts.

To stanch a money market fund collapse, Bernanke announced on October 21 that, on top of the Paulson bailout plan, the Fed stands ready to purchase $540 billion in certificates of deposit and private business loans from the money market funds. This action is in addition to two previous initiatives committing the Fed to buy up, as needed, business loans from failing banks. Until this crisis, the Fed had conducted monetary policy almost exclusively through the purchase and sale of Treasury bonds, rarely buying directly the debts of private businesses or banks. But the pre-crisis rules of monetary policy are out the window.

Even if some combination of Treasury and Federal Reserve actions begins to stabilize financial markets in the coming weeks, this will not, by itself, reverse the deepening crisis in the nonfinancial economy. A rise in unemployment in the range of 8 to 9 percent -- upward of 14 million people without work -- is becoming an increasingly likely scenario over the next year.

President-elect Obama as well as most members of the newly elected Democratic-controlled Congress seem to recognize the urgency of such a large-scale stimulus program above and beyond any financial bailout program. Even Bernanke, whose term of office continues through January 2010, has offered his endorsement. But despite the near consensus, questions remain, including: How should the stimulus funds be spent? How large does the stimulus need to be? Where do we find the money to pay for it?

A Green Public-Investment Stimulus

Recessions create widespread human suffering. Minimizing the suffering has to be the top priority in fighting the recession. This means expanding unemployment benefits and food stamps to counteract the income losses of unemployed workers and the poor. By stabilizing the pocketbooks of distressed households, these measures also help people pay their mortgages and pump money into consumer markets.

Beyond this, the stimulus program should be designed to meet three additional criteria. First, we have to generate the largest possible employment boost for a given level of new government spending. Second, the spending targets should be in areas that strengthen the economy in the long run, not just through a short-term money injection. And finally, despite the recession, we do not have the luxury of delaying the fight against global warming.

To further all these goals we need a green public-investment stimulus. It would defend state-level health and education projects against budget cuts; finance long-delayed upgrades for our roads, bridges, railroads and water management systems; and underwrite investments in energy efficiency -- including building retrofits and public transportation -- as well as new wind, solar, geothermal and biomass technologies.

This kind of stimulus would generate many more jobs -- eighteen per $1 million in spending -- than would programs to increase spending on the military and the oil industry (i.e., new military surges in Iraq or Afghanistan combined with "Drill, baby, drill"), which would generate only about 7.5 jobs for every $1 million spent. There are two reasons for the green program's advantage. The first factor is higher "labor intensity" of spending -- that is, more money is being spent on hiring people and less on machines, supplies and consuming energy. This becomes obvious if we imagine hiring teachers, nurses and bus drivers versus drilling for oil off the coasts of Florida, California and Alaska. The second factor is the "domestic content" of spending -- how much money is staying within the US economy, as opposed to buying imports or spending abroad. When we build a bridge in Minneapolis, upgrade the levee system in New Orleans or retrofit public buildings and private homes to raise their energy efficiency, virtually every dollar is spent within our economy. By contrast, only 80 cents of every dollar spent in the oil industry remains in the United States. The figure is still lower with the military budget.

What about another round of across-the-board tax rebates, such as the program the Bush administration and the Democratic Congress implemented in April? A case could be made for this in light of the financial stresses middle-class families are facing. However, even if we assume that the middle-class households will spend all the money refunded to them, the net increase in employment will be about fourteen jobs per $1 million spent -- about 20 percent less than the green public-investment program (the main reason for this weaker impact is the lower domestic content of average household consumption). Also, it isn't likely that the households would spend all their rebate money. Just as with April's rebate program, households would channel a large share of the money into paying off debts.

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