What do we do about a slowing economy?

My rosy forecasts for economic growth coming out of this recession are not looking so good right now. Employment growth in March and April suggested a strong recovery. May and June's numbers, however, provide unmistakable evidence that the economy is slowing down. Private sector employment increased by 33,000 in May and 83,000 in June, well below the pace needed to make a dent in unemployment. Hours worked increased by only a tiny bit in June, so that total growth in hours in the second quarter is only 2.4 percent, the same as in the first quarter. Hence my best guess is that GDP grew no better in the second quarter than the first (3-3.5 percent, versus my guess of 4.5-5 percent based on April-May's data). What's going on out there?

Well, it seems as if in the race between the forces of recovery (pent up demand, expansionary monetary and fiscal policy) and the forces of contraction (consumer debt, oversupply of housing, pressure on state and local budgets, general lack of confidence) the forces of contraction have taken the lead. Awhile ago I thought that the prudent course of action was a "small" (on the order of $100 billion or so) stimulus focused on aid to the unemployed and state governments to guard against a slowdown. Now the slowdown seems to be upon us, anyone with a brain would agree that a stimulus package of that size or larger is the way to go. Unfortunately, people with brains seem to be very scarce in the policymaking and opinion-forming communities.

Paul Krugman and Brad DeLong have written several pieces lately asking how it is that Keynesians seem to have lost the argument on policy to the deficit hawks. The best answer seems to me to be the attractiveness of false prudence in times of crisis. We got into this mess because of over-indulgence. The cure must be to tighten our belts and accept our punishment. Reduce the budget deficit, put a halt to the rise in debt, take our lumps, and things will be all right. Well, that is clearly nonsense: the problem we face right now is that people and businesses prefer to hoard money rather than spend it. The solution must be to stimulate spending, which means that the government needs to borrow more, not less. But something about calling for more "irresponsibility" on the part of government at this time is deeply unattractive to an important segment of our polity (largely, though I suppose not exclusively, that segment that is securely employed such as politicians and journalists). And so here we sit, unable to do the obvious things like extend benefits to the unemployed and states that might get us out of this mess.

When people try to come up with a logical argument for austerity they focus on the effects of austerity on "confidence". David Brooks's column in today's NY Times is a particularly asinine version of this line of reasoning. First he paints an absurd caricature of proponents of stimulus (without naming anyone or citing specifics, of course) as arrogant and overly confident in their theoretical models. Nothing could be further from the truth: we all admit that we're in uncharted territory here (well, territory that has been charted only a couple of times in history) and allow for a wide range of uncertainty in our prescriptions). Then he idolizes the non-egghead, commonsense man on the street who somehow has accumulated more wisdom about the workings of the macroeconomy than the so-called "experts". And he summarizes their wisdom thusly:

You can't read models, but you do talk to entrepreneurs in Racine and Yakima. Higher deficits will make them more insecure and more risk-averse, not less. They're afraid of a fiscal crisis. They're afraid of future tax increases. They don't believe government-stimulated growth is real and lasting. Maybe they are wrong to feel this way, but they do. And they are the ones who invest and hire, not the theorists.

Is there a word for arrogant anti-elitism, the flaunting of ignorance as a badge of honor? Brooks is bathing in this, whatever it is. Would it do any good to point out that there is no evidence that business people are not investing or hiring because of fear of deficits or future tax increases (as opposed to the fear that no one is going to buy their stuff)? Probably not, because reliance on "facts" and "evidence" is too eggheady for the likes of Brooks. But for the record, if people with money were really afraid of a fiscal crisis, they would hesitate to buy government debt. The government would have to pay a premium to borrow - we'd see a big spike in interest rates. The truth? The interest rate on 10-year government bonds is 3.2 percent, which is ridiculously low. The expected inflation rate implied by the difference between the interest rate on regular government bonds and bonds that are indexed to inflation (TIPS) is about 2 percent, the same as it's been for decades.

Even renowned economists are capable of spouting nonsense about the advisability of stimulus. Ed Glaeser counseled in today's Times (the link has disappeared - perhaps he had second thoughts) against the government spending money on infrastructure and other things that we don't need. A waste of resources, he says, echoing the austere gentlemen who ran the British Treasury in the early 1930s as the British economy descended into a death spiral. What is a greater waste of resources - millions of people unemployed, or using some of those unemployed to build highways?

Government spending, either directly or through aid to states and the unemployed, is an essential part of the answer to the problem we face. The Obama Administration needs to make this its number one priority this summer. The Senate has to be convinced to take action now - otherwise the Democrats are doomed, and a Republican dominated legislature is bound to pursue the wrongheaded (but strangely morally satisfying) policies next year that will extend our economic misery for years to come.