Why the stimulus didn't work, and what could

Policymakers need to understand that credibility trumps stimulus in promoting growth.

Brendan McDermid/Reuters
A trader looks at his screen on the floor of the New York Stock Exchange June 29. Investors fled the US stock market last week and the S&P 500 tumbled to its lowest level in eight months in a sell-off triggered by a wave of increasing alarm over the global economic outlook. The markets, and the economy, need a sense of certainty to expand.

The short-term outlook continues to be bleak for the U.S. economy. Though I'm not in the Krugman camp for policy reasons, I concur with his macro pessimism. I still haven't gotten the memo that the recovery has arrived. My reasons:

1. Jim Hamilton (via Bill Gavin) adjusts the unemployment rate.

2. Jobless Claims have not cauterized. Anything above 400,000 new claims per week means the economy is bleeding out. This morning's weekly release is 472,000, the high level its been stuck at for ... years. You can't hype how bad this is.

3. There's an analogy to oil bleeding out in the gulf. Maybe it's time to blow it up?

4. Home prices will drop another 5-10%, says Calculated Risk.

5. Policymakers are out of ammo (see my Depression Index, which hasn't changed much in the year since I described it). But wait ... maybe this is good news!

I recommend John Tamny's essay in the WSJ today about postwar Germany's rejection of "spending Keynesianism" in favor of what I call "tax-cut Keynesianism." Krugman's notion of big push stimulus has failed spectacularly, again, and it's time to respect the empirical outcome.

So, here's the good news. Economies are dynamically stable, not dynamically unstable. Any economy naturally finds an equilibrium if only the masters of institutional policy will let it. But the animal spirits need a sense of certainty, something sorely lacking in the U.S. right now. Without certainty, state policymakers will continue to make fantasy budgets. Without certainty in mortgage tax credits, no one will know when home prices are real. But once genuine commitments to fiscal stability and tax policy are made, the transition to real growth will be swift. Remember, the credibility story was validated regarding monetary policy in fighting inflation (see Volcker, Paul). We need our policymakers to understand that credibility trumps stimulus in promoting growth.

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