A Word of Clarification
My blog post below has struck a chord with some of you. As a Vanguard blogger, I am charged with sharing my personal and professional perspectives on issues facing investors. The post, prompted by a discussion I had with a fellow passenger during a recent flight, represents my understanding of how the federal economic stimulus programs might be viewed historically. The focus is on certain macroeconomic principles and is not intended to endorse specific political leaders or parties. More importantly, my views are my own and not necessarily those of Vanguard, and they do not influence how the company manages our clients’ assets. I regret if some readers have interpreted the posting as representing a partisan point of view. Steve
Someone asked me recently about the main federal economic stimulus programs and how they might be viewed historically.
My response was simple: They will be viewed as the tools that help us avoid Depression 2.0.
In response to the mortgage crisis and potential collapse of the financial system, the U.S. government initiated three large stimulus programs. The first was the bank rescue plan (TARP), created under President Bush. The second was a huge expansion of the money supply engineered by the Federal Reserve, including trillion-dollar purchases of debt securities. (Think of this as the bipartisan initiative—the Fed chairman, Ben Bernanke, is a Bush appointee subsequently reappointed by President Obama.) The third stimulus was the nearly $800 billion package of spending programs and tax cuts initiated under the Obama administration.
The TARP, the first initiative, stabilized the financial system. Absent TARP, it’s reasonable to assume that at least several additional Wall Street firms would have collapsed, leading to even worse financial markets and economic conditions. The second initiative, the Fed’s large debt purchases, kept interest rates at low levels, and so allowed weak commercial banks to avoid insolvency. Low rates also kept the housing market and overall economic growth from collapsing even further.
Finally, the third stimulus bill. The Congressional Budget Office says that it saved as many as three million jobs, and cut the unemployment rate by up to 2%—though there is a lot of uncertainty around these estimates.
There were, and are, many ways to criticize the third program, the spending bill. It could have included more tax cuts relative to spending (though the tax cuts would have been best targeted at low-income households, who are more likely to spend the money). It could have included more direct payments for job creation. It could have included concentrated spending on a targeted initiative, like infrastructure, rather than a potpourri of individual projects.
These seem to me legitimate points of criticism. But the idea that no third stimulus was needed seems mistaken.
When consumer spending and corporate investment are collapsing, as they were during the crisis, an expansion of fiscal policy is needed to soften the blow. That’s the lesson of Economics 101: Y = C + I + G + X. Economic output (Y) is the sum of consumer spending (C), corporate investment (I), government spending (G), and net exports (X). When C and I are plummeting, more G (though government spending increases, tax cuts intended to boost C and I, or a combination) is the only realistic way to cushion the downturn.
Now what about my friend’s hypothetical question—what would have happened if all three stimulus programs hadn’t taken place? In some ways, it’s a difficult question to answer. No economic model does a good job capturing extreme scenarios or outcomes.
My own guess would be economic conditions that would be an order of magnitude worse than our current situation: unemployment of 15% or more. A Dow that would have fallen 75% off its peak—to 4,000 or less—before recovering to a level much below today’s. An economic recovery that might not yet have begun. And finally a foreclosure crisis even larger than our present one.
Hence my early view of history’s judgment. The three stimulus programs helped avoid Depression 2.0, even though they were insufficient to offset the effects of the largest financial crisis since Depression 1.0.