Bruce Bartlett on the need for a stimulus

Bruce Bartlett, past chief economist for the Reagan and first Bush administrations, was a supporter of the stimulus package much to the chagrin of many of his conservative colleagues. In a recent talk (found here) he explains why.

Essentially it is because of parallels he found between the causes of the Great Depression and the Great Recession.  The critical parallel was the decline in money that preceded each crash. With the Depression, it was a decline in the money supply. But while that was not exactly the case today it was something similar, it was a decline in the velocity of money. That is, the decline in the amount and speed with which money turned over in the economy. In the first crash, the money dried up and people couldn’t sell things, so the economy imploded. In the second, the speed with which the money flushed around in the economy (the “velocity”) dried up, and it (more or less) had the same affect on the economy.

The basic equation of GDP is:  
Money supply times velocity equals the prices of goods (times quantity of goods)
(M x V = P) x Q

If velocity falls by ten percent, it has the same impact as if the money supply shrinks by ten percent.

The ratio of the money supply to GDP is normally about 1.9, that’s the velocity. But right now it’s about 1.7. And if you multiply the money supply by 1.9, GDP would be on and a half trillion dollars higher. So, what’s happening in the economy is (among other things and related to other factors) that there is not enough money flushing around in the economy, buying goods, and allowing retailers to buy products and hire workers, and wholesalers to increase products and hire workers, and manufacturers to create products, etc. down the economic chain. It’s the same process that Milton Friedman had actually described in his book decades ago, and the remedy is the same that we used (badly and haltingly) back during the Great Depression: when private spending collapses, you need to substitute public spending to get the ball rolling, to prime the pump, to stimulate growth. It can’t be just monetary policy. The federal reserve cannot by itself increase the quantity of liquidity in the economy. It needs something to pull the economy along to get people spending again to get the turnover, the velocity of money flowing.

He admits that the stimulus package was not well designed and could have been whole lot better, but it was a step in the right direction. When a building is burning, you have to act. If we had not had it, we would have had a disaster. To do nothing, as many politicians and a small handful of economists have proposed, would have been to drive us into a depression at least as deep as the Great Depression, and perhaps deeper.