Friday, February 6, 2009

A new New Deal?

By Douglas Kohn

One of the most egregious media perversions I have seen in the last few months is that of President Obama’s face replacing Franklin Roosevelt’s in a famous picture on the cover of Time Magazine. The article inside was calling for a ‘New New Deal.’

Put simply, the New Deal did not work. It has been the most overhyped government program in our history. What the New Deal did do, was provide a little temporary relief for very desperate people but it was World War II that finally ended the Great Depression.

In 1940, President Roosevelt passed the Lease Lend Act, allowing the United States to supply the British Empire with armament when it had to face the storm of Hitler alone. This was when real economic output began to pick up. Massive government orders of armament to factories allowed for renewed economic activity which created jobs and as people earned money, allowed them to consume again.

After the Great Depression, John Maynard Keynes became the Economic giant of his time. He believed that massive government stimulus could prevent a repeat of the Great Depression. A running competition between Keynesians and Supply Siders has been the great debate of politicians and economists ever since.

The general consensus among economists seems to be that while government spending should increase in a recession, stimulus should be in the form of tax cuts rather than freewheeling government spending. Spending on infrastructure is always appropriate and should be increased during recessions, but the rest of the stimulus should come in the form of massive tax cuts. Many of these tax cuts should be targeted.

The stimulus bill that has passed the House and is now working its way to the Senate is an embarrassment. It includes nonsensical appropriations such as $335 million for birth control.

The root of this problem is still the crisis in housing. Existing homes inventory is still too high to allow for sustained economic recovery. Giving workers an extra few hundred dollars a piece is not going to entice consumers to renew their spendthrift ways. Therefore, the most important part of any stimulus package should be a tax cut or credit for people buying existing homes. Building new homes will create some jobs but is only going to make the problem worse because it will increase supply without liquidating excess inventory.

Some of the conditions relating to 1929 are similar. After the crisis, people had been buying on credit for so long that companies had greatly overproduced relative to demand. After the crash, it becomes necessary to dispose of excess inventory otherwise a nearly unstoppable deflationary spiral will ensue. We are not yet in a deflationary cycle. Due to high oil prices inflation in the second quarter of 2008 was running at nearly 5%, whereas in the 4th quarter inflation was running at 1% (if you believe government statistics). This means deflation has not yet occurred but the drastic decrease in inflation suggests that it will in the first half of 2009.


Phil said...

Couldn't agree more with your assessment of the New Deal and with your tax credit for home buyers idea.

First let me state the Great Depression as a whole is one of the most misunderstood events in American history. People are quick to blame President Coolidge and his free-market policies and are quick to praise President Roosevelt for saving the economy. This is simply untrue. Milton Friedman argued, and successfully so, that the Depression was caused by a massive decrease in the money supply triggered by the collapse of numerous banks around the nation. Because monetary policy was not as exact a science as it is today the Fed did not react and what was a recession launched into Depression. As for FDR saving us, you are 100% right. The New Deal provided nice relief for those in need, but on a Macro level did very little. WWII knocked America out of the Depression.

Second, I haven't heard a suggestion of tax credits for purchasing homes until now but I think its a great idea. The housing market clearly needs a jolt to demand and this type of policy action would do just that. I also still believe a cut (or even suspension) of the capital gains tax for a 2 year period would do wonders for the stock market, which always leads to people feeling more confident about the economy and thus increases in GDP.

DSKohn said...

Thank you but I cannot take credit for it. It is the brainchild of Senator Isakson of Georgia I believe. First time I heard the idea was on CNBC.