Krugman's Letter to Obama

Here's an article in Rolling Stone magazine where Paul Krugman lays out what Obama has to do to save the economy.

First, he points out how the ideological illusion created a pseudo-economy:

The economic growth of the Bush years, such as it was, was fueled by an explosion of private debt; now credit markets are in disarray, businesses and consumers are pulling back and the economy is in free-fall. What we're facing, in essence, is a yawning job gap. The U.S. economy needs to add more than a million jobs a year just to keep up with a growing population. Even before the crisis, job growth under Bush averaged only 800,000 a year — and over the past year, instead of gaining a million-plus jobs, we lost 2 million. Today we're continuing to lose jobs at the rate of a half million a month.

There's nothing in either the data or the underlying situation to suggest that the plunge in employment will slow anytime soon, which means that by late this year we could be 10 million or more jobs short of where we should be.

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Compare the situation right now with the one back in the 1980s, when Volcker turned the economy around. All the Fed had to do back then was print a bunch of dollars (OK, it actually credited the money to the accounts of private banks, but it amounts to the same thing) and then use those dollars to buy up U.S. government debt. This drove interest rates down: When Volcker decided that the economy needed a pick-me-up, he was quickly able to drive the interest rate on Treasury bills from 13 percent down to eight percent. Lower interest rates on government debt, in turn, quickly drove down rates on mortgages and business borrowing. People started spending again, and within a few months the economy had gone from slump to boom. Economists call this process — from the Fed's decision to print more money to the resulting pickup in spending, jobs and incomes — the "monetary transmission mechanism." And in the 1980s that mechanism worked just fine.

This time, however, the transmission mechanism is broken.

First of all, while the Fed can still print money, it can't drive interest rates down. Why? Because those interest rates are already about as low as they can go. As I write this letter, the interest rate on Treasury bills is 0.005 percent — that is, zero. And you can't push rates lower than that. Now, you might think that zero interest rates would lead to an orgy of borrowing. But while the U.S. government can borrow money for free, the rest of us can't. Fear rules the financial markets, so over the past year and a half, as the interest rates on government debt have plunged, the interest rates that Main Street has to pay have mostly gone up. In particular, many businesses are paying much higher interest rates now than they were a year and a half ago, before the Fed started cutting. And they're lucky compared to the many businesses that can't get credit at all.

Then he spells out what needs to be done...

The last president to face a similar mess was Franklin Delano Roosevelt, and you can learn a lot from his example. That doesn't mean, however, that you should do everything FDR did. On the contrary, you have to take care to emulate his successes, but avoid repeating his mistakes.

About those successes: The way FDR dealt with his own era's financial mess offers a very good model. Then, as now, the government had to deploy taxpayer money in order to rescue the financial system. In particular, the Reconstruction Finance Corporation initially played a role similar to that of the Bush administration's Troubled Assets Relief Program (the $700 billion program everyone knows about). Like the TARP, the RFC bulked up the cash position of troubled banks by using public funds to buy up stock in those banks.

There was, however, a big difference between FDR's approach to taxpayer-subsidized financial rescue and that of the Bush administration: Namely, FDR wasn't shy about demanding that the public's money be used to serve the public good. By 1935 the U.S. government owned about a third of the banking system, and the Roosevelt administration used that ownership stake to insist that banks actually help the economy, pressuring them to lend out the money they were getting from Washington. Beyond that, the New Deal went out and lent a lot of money directly to businesses, to home buyers and to people who already owned homes, helping them restructure their mortgages so they could stay in their houses.

Can you do anything like that today? Yes, you can. The Bush administration may have refused to attach any strings to the aid it has provided to financial firms, but you can change all that. If banks need federal funds to survive, provide them — but demand that the banks do their part by lending those funds out to the rest of the economy. Provide more help to homeowners. Use Fannie Mae and Freddie Mac, the home-lending agencies, to pass the government's low borrowing costs on to qualified home buyers. (Fannie and Freddie were seized by federal regulators in September, but the Bush administration, bizarrely, has kept their borrowing costs high by refusing to declare that their bonds are backed by the full faith and credit of the taxpayer.)

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The lesson from FDR's limited success on the employment front, then, is that you have to be really bold in your job-creation plans. Basically, businesses and consumers are cutting way back on spending, leaving the economy with a huge shortfall in demand, which will lead to a huge fall in employment — unless you stop it. To stop it, however, you have to spend enough to fill the hole left by the private sector's retrenchment.

How much spending are we talking about? You might want to be seated before you read this. OK, here goes: "Full employment" means a jobless rate of five percent at most, and probably less. Meanwhile, we're currently on a trajectory that will push the unemployment rate to nine percent or more. Even the most optimistic estimates suggest that it takes at least $200 billion a year in government spending to cut the unemployment rate by one percentage point. Do the math: You probably have to spend $800 billion a year to achieve a full economic recovery. Anything less than $500 billion a year will be much too little to produce an economic turnaround.

Spending on that scale, at a time when the weakening economy is driving down tax collection, will produce some really scary deficit numbers. But the consequences of too much caution — of a failure on your part to do enough to stop the economy's nose dive — will be even scarier than the coming ocean of red ink.

And here's the real zinger...

Crisis management is one thing, but America needs much more than that. FDR rebuilt America not just by getting us through depression and war, but by making us a more just and secure society. On one side, he created social-insurance programs, above all Social Security, that protect working Americans to this day. On the other, he oversaw the creation of a much more equal economy, creating a middle-class society that lasted for decades, until conservative economic policies ushered in the new age of inequality that prevails today. You have a chance to emulate FDR's achievements, and the ultimate judgment on your presidency will rest on whether you seize that chance.

And here is where he makes a moral/political point:

There is, however, one area where I feel the need to break discipline. I'm an economist, but I'm also an American citizen — and like many citizens, I spent the past eight years watching in horror as the Bush administration betrayed the nation's ideals. And I don't believe we can put those terrible years behind us unless we have a full accounting of what really happened. I know that most of the inside-the-Beltway crowd is urging you to let bygones be bygones, just as they urged Bill Clinton to let the truth about scandals from the Reagan-Bush years, in particular the Iran-Contra affair, remain hidden. But we know how that turned out: The same people who abused power in the name of national security 20 years ago returned as part of the team that, under the second George Bush, did it all over again, on a much larger scale. It was an object lesson in the truth of George Santayana's dictum: Those who refuse to learn from the past are condemned to repeat it.

That's why this time we need a full accounting. Not a witch hunt, maybe not even prosecutions, but something like the Truth and Reconciliation Commission that helped South Africa come to terms with what happened under apartheid. We need to know how America ended up fighting a war to eliminate nonexistent weapons, how torture became a routine instrument of U.S. policy, how the Justice Department became an instrument of political persecution, how brazen corruption flourished not only in Iraq, but throughout Congress and the administration. We know that these evils were not, whatever the apologists say, the result of honest error or a few bad apples: The White House created a climate in which abuse became commonplace, and in many cases probably took the lead in instigating these abuses. But it's not enough to leave this reality in the realm of things "everybody knows" — because soon enough they'll be denied or forgotten, and the cycle of abuse will begin again. The whole sordid tale needs to be brought out into the sunlight.

There's lots more. Read the whole article!