Cross-posted on Facebook
I don't suppose (in 500 words or less) :) you could explain the stimulus package to me?!?!? ... in a capitalist society (that in theory we live in) when the government bails out large corporations again and again how does this help the average joe? And, how does all of this help the person who pays their bills on time, owns a home and actually owes less than it is worth? I don't think I am an "all about me" kind of person, but there really isn't an incentive to work hard when if I don't, I can go to the government for funds. *** argues that it has always been like that - we have welfare and things that were meant to be short term solutions that now are going on for decades, but it seems bigger to me this time. Maybe because I am an adult living through it...
500 words or less...tough ;) I can't explain the details of the stimulus package, but let me take a shot at why it would happen at all. (This is not me advocating, just explaining). Prior to the Great Depression there was this idea in classical economics that wages and prices adjusted very rapidly (effectively instantly) to changes in demand, outlook, etc. This implies that you can never have a prolonged depression. Booms and busts will happen, they are part of human nature, but when they do, capital will be reallocated quickly to more productive uses and growth will march forward after brief sharp pain. This did not happen in the 1930's, and there are huge fights over why still to this day. One view point advanced by Keynes was the idea of the liquidity trap. Briefly, classical economists believed that no one would ever want to actually hold money (currency) for a long time, because it was not productive and would not make them better off. Keynes partially explained the Depression as this huge change in peoples' desire to hold currency instead of investments, which sucked liquidity out of the economy and caused things to spiral downward. Typically a monetary authority such as our Federal Reserve would lower interest rates to induce money back in to the market--i.e. borrowing costs become very low, making investment projects more profitable, and at the same time rewards for holding cash become very low, so people try and turn their cash into investments. There is this possibility however that even with interest rates at zero, people will be so afraid of capital losses (or deflation) that their fear will overwhelm this monetary inducement to invest. Keynes thought that this made monetary policy impotent in that situation. He further thought that this fear/paralysis could last a long time and that this would essentially mean that it would take forever for markets to recover to their prior levels of productive output. This led him to conclude that it times like these, governments should borrow and spend to replace the capital that individuals were hoarding out of fear and to ensure that things did not spiral downwards unnecessarily. It is similar to why economists like credit cards for individuals---it allows them to smooth consumption over time even if their flows of income are uneven. It is important to remember that he wanted governments to pay this temporary debt off when things turned around such that net government stimulus over the cycle would be zero. Ok---let's grant that in theory he is probably right. May not be true but let's give him the benefit of the doubt.
In the best of all worlds, a government with perfect foresight would be able to conclude whether or not people had rational or irrational fear about the future that caused investment to cease, and if it were irrational they would quickly invest in worthy projects which would restore confidence and keep things moving. You can object to this on many levels. You might believe as I do that there should be severe limits on the role of government, and that their low borrowing costs come strictly from their ability to coerce their citizens into repaying government debts with higher taxes. In this view, most government spending is immoral...it improperly deprives people of the product of their labor for no good reason. Read Bastiat for more:
Let's say you don't believe that and let's give the government credit for good and moral intentions. They want and believe that they are doing the right Economic thing with stimulus. You still have this problem of the political process, which uses decent ideas as a rhetorical device for support, but in actual fact produces concentrated benefits for the constituents of politicians which secures their power at high expense, and without the "keynesian multiplier" everyone is looking for. In this view, even if the Keynesians are right in theory about the efficacy of their approach, they can never be right in practice. I think this is the likely state of the world. Keynesians are a bit like believers in Communism, who continue to argue that it would work, only if people were better, more public spirited, etc. Sorry..people respond to incentives. In Communism the incentive is to slack off, and in political Keynesianism the incentive is to use stimulus as patronage.
So that's maybe why stimulus, and also why I think it won't work as advertised. As for bailouts, also complex. I think we have to separate the banking system from everything else because of some preexisting legislative conditions. Fact one---the government controls the currency and therefore the money supply. Fact two--most "money" is actually created by banks. Every dollar of currency becomes effectively ten dollars of "money" through fractional reserve banking--loans create new money. Fact three--the government views banks as agents of social policy--they transform peoples' desire for short term savings and liquidity into long term investments through financial intermediation, and investment leads to increased productivity leads to growth. Fact four--because of fact three, governments like to guarantee liabilities of banks--think FDIC deposit insurance--so that people will have the confidence to put their money there, and new investment will be facilitated.
Given this set of facts, you have to think of bank bailouts as bailouts of bank liability holders, not bank equity holders (essentially everyone else except the bank). I mean the equity of almost all of our major financial institutions has been nearly wiped out. When the government attempts to prevent loss to bank liability holders, they are ultimately trying to bail themselves out. If Citibank fails, the losses will overwhelm the FDIC's ability to repay the liabilities. The fear is that if you throw these losses into the legal system--bankruptcy--the whole financial system and maybe even the legal system will be overwhelmed and temporarily shut down (see Lehman Brothers aftermath). It is important to remember that these "bailouts" are probably only happening because the government put themselves on the hook for so much of this stuff in the first place---deposit insurance, government mortgage agencies such as Fannie and Freddie, etc. The fact that some bad managers get to keep their jobs is a very unfortunate side affect of these other realities, but there is probably a real shortage of people that have the skillset to run any of these institutions. Also, as you say--government guarantees create terrible incentives in the first place, and on some level they are the genesis of the depth of the current problem we have.
As for bailing out anyone in general--probably a bad idea. The virtue of capitalism is that when people use capital in such a way that the benefits don't outweigh the costs, they lose that capital. It is self-correcting in that sense. Anytime you hear a politician talk about saving "jobs" you can be assured that there is no good reason for whatever they are doing. Jobs exist only to facilitate the productive use of capital...they "belong" to owners, not workers. What workers own is their producitivity, their "human capital", which they can and should use for other purposes if the market signals that its current use is not valuable enough. It is undeniably true that there are frictions in job loss. Our economy is so specialized that retraining human capital to new uses takes a long time and a lot of investment---think college expense. This is why some form of unemployment insurance seems so necessary to smooth functioning job markets. What you should be asking is should the government provide this insurance, or could the private market do a better job---think AFLAC duck on steroids. This goes to a deeper issue between Libertarian-types and everyone else. Many people think that if someone does not advocate government unemployment insurance, health care, or social security, they are in effect advocating no help to starving, unemployed, old people. This is a huge fallacy. Protesting against a government solution has nothing to do with whether or not you think that smooth functioning society needs those who have resources to care about and supply those who do not. It is a debate over the proper channel of help.
So, how does this all help average Joe? In theory, saving the banking system means that credit will continue to be provided very cheaply to the American people or to their employers as it has been getting continually cheaper/easier to get for the last 60+ years. If this goes away our current standard of living will drop off pretty dramatically in the short term. The longer term issue is what level of debt relative to income is sustainable, and how much of the increase in our standard of living is illusory--simply the result of using too much debt. This is a very hard question to answer. In the same way, the plans for mortgage modification etc might stabilize the housing market in the short term, but one wonders what will happen to people who want to get mortgages in the future. Banks will probably be less eager to create mortgage assets for themselves, which should have the effect of making mortgages more expensive / harder to get. From a societal and moral point of view, rewarding the inefficient and unproductive at the expense of the productive is not sustainable.
Anyway, sorry that was so long-winded. I think I failed the 500 word test, but I hope it will be helpful.