Krugman's Letter To Obama: The Economy is Worse Than Anyone Imagined

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Ben Cohen
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By Ben Cohen

The sobering but brilliant letter written by the economist Paul Krugman to Obama in Rolling Stone Magazine outlines just how bad the economic crisis is, and what he believes Obama must do to reverse it. Krugman believes that the economy is on the verge of a complete meltdown, and only massive government intervention can turn it around. I've tried to summarize the key points for Krugman's immediate recovery program below. He writes:

The


Center on Budget and Policy Priorities, a nonpartisan research


group that analyzes government programs, recently estimated the


effects of a rise in the unemployment rate to nine percent —


a worst-case scenario that now seems all too likely. So what will


happen if unemployment rises to nine percent or more? As many as 10


million middle-class Americans would be pushed into poverty, and


another 6 million would be pushed into "deep poverty," the severe


deprivation that happens when your income is less than half the


poverty level. Many of the Americans losing their jobs would lose


their health insurance too, worsening the already grim state of


U.S. health care and crowding emergency rooms with those who have


nowhere else to go. Meanwhile, millions more Americans would lose


their homes. State and local governments, deprived of much of their


revenue, would have to cut back on even the most essential


services.

Krugman's message to Obama is a stark one:

If things continue on their current trajectory, Mr. President,
we will soon be facing a great national catastrophe. And it's your
job — a job no other president has had to do since World War
II — to head off that catastrophe.

The letter continues for several pages where Krugman outlines why this crisis is unlike no other in recent history, and why the Federal Reserve cannot come to the rescue as it did in the 80's:

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.

Part of Krugman's solution is to force banks that are receiving bailout money to lend again, regardless of the political consequence:

Conservatives will accuse you of nationalizing the financial
system, and some will call you a Marxist. (It happens to me all the
time.) And the truth is that you will, in a way, be
engaging in temporary nationalization. But that's OK: In the long
run we don't want the government running financial institutions,
but for now we need to do whatever it takes to get credit flowing
again.

But Krugman also says that nationalizing the banking system wont go far enough. He writes:

To pull the economy out of its slide, you need to
go beyond funneling money to banks and other financial
institutions. You need to give the real economy of work and wages a
boost. In other words, you have to get job creation right —
which FDR never did.

How much will this cost? Krugman states:

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.

Krugman also believes that tax cuts in the short term will be useful:

Even if you do all this, however, it won't be enough to offset


the awesome slump in private spending. So yes, it also makes sense


to cut taxes on a temporary basis. The tax cuts should go primarily


to lower- and middle-income Americans — again, both because


that's the fair thing to do, and because they're more likely to


spend their windfall than the affluent. The tax break for working


families you outlined in your campaign plan looks like a reasonable


vehicle.

It is clear from Obama's actions over the past few days that he is serious about responding to this crisis. He has tried to shore up Republican support for this issue adding tax cuts for business and individuals and having them play a big part in the process. But the time may come when Obama has to put the Republicans in their place and get on with the job at hand. Republican economics caused this crisis in the first place, so God knows why anyone should listen to their solutions. The window of opportunity is closing, and Obama's success as a President will be defined by what he does right now. Obama has listened to people like Krugman, so is full aware of the arguments - a good sign if ever there was one.