Government’s $2 trillion economic bailout – Saved for now, pay much bigger price later?

Editor’s note: Dr. Mike Walden is aWilliam Neal Reynolds Distinguished Professor and Extension Economist in the Department of Agricultural and Resource Economics at North Carolina State University who teaches and writes on personal finance, economic outlook, and public policy.

RALEIGH, N.C. – Most economists, including yours truly, think the economy is in one of the worst recessions in the last 50 years. Ultimately, unemployment could hit 10 percent. The loss in household wealth will likely top $10 trillion. And like their constituents, local and state governments are facing declining or slowing revenues, meaning many public programs will likely be curtailed.

To the rescue has come the federal government. The federal help has come in two ways. First is additional federal spending, in the form of loans and investments to banks and other financial firms, tax rebates to consumers, and – coming in the future – a variety of infrastructure projects. The total bill for these efforts will likely top $2 trillion.

The second prong of the federal cavalry has come from the nation’s central bank, the Federal Reserve. The Federal Reserve has lowered interest rates to encourage private borrowing and spending, has made loans to and purchases of debt from banks, and has increased use of their ultimate weapon – the printing of money.

The theory behind these tactics by the federal government was developed 70 years ago and is fairly simple. The essential problem of a recession is a shortfall of spending. Businesses and consumers aren’t spending enough to maintain income and employment levels. Consequently, jobs are cut and incomes are reduced.

What’s the answer? One is to just “let things work themselves out”. If businesses aren’t selling, they’ll drop their price. If workers don’t have jobs, they’ll be willing to work for less. At some point people will see these lower prices and lower wages as bargains they can’t pass up. So both spending and hiring will eventually increase, thereby pulling the economy out of its nosedive.

In the 19th and early 20th centuries this was our approach to recessions. The attitude was that recessions were self-correcting. In other words, things got so bad that they were actually good. The glass was half full rather than half empty. Collectively we pulled ourselves up by our bootstraps.

The problem was that the recessions could be deep – very deep – before a change in attitude brought an economic rebound. And when the greatest of all recessions hit us in the 1930s, it got people to thinking if there was a better way.

The plan that was developed was to use the government as a countervailing force. So if businesses and consumers weren’t spending, the idea was to have the government spend. The government would borrow or create money and use it to cut taxes – thereby increasing consumer spending power – or spend it on building or buying things, thus creating work and jobs for private companies and workers.

The government’s “pump priming” is designed to increase economic growth and ultimately end the recession. But, as economists have long pointed out, these efforts don’t come without costs. Increased government borrowing means a larger government debt, greater future interest payments on that debt, and either less government money to spend on other programs or higher taxes. Plus, more money creation from the Federal Reserve can lead to faster rising prices – that is, higher inflation – in the future.

Hence, the “big tradeoff”. With the federal government spending more to contain the recession, we can have more income and more jobs now than without the federal efforts. For example, some economists estimate that without the federal government’s efforts, unemployment could be two percentage points higher and over 3 million more jobs could be lost.

But the downside is that if inflation, taxes, and debt are all higher in two or three years, incomes and jobs will be lower than they would have been without these negatives. So we may be trading more growth, more income, and more jobs today for less growth, less income, and fewer jobs tomorrow.

There’s one possible way out of this dilemma. If the additional government spending today is on projects and programs that are so beneficial and so worthwhile that they dramatically boost the productivity and efficiency of the economy, then the new “buffed” economy may be able override the adverse effects of more debt and inflation.

The stakes in our economy are high. You decide if the “big tradeoff” we’re embarked upon is a strategy that will pay off.