Obama's Rhetoric Is the Real 'Catastrophe'

President Barack Obama has turned fearmongering into an art form. He has repeatedly raised the specter of another Great Depression. First, he did so to win votes in the November election. He has done so again recently to sway congressional votes for his stimulus package.

AP

In his remarks, every gloomy statistic on the economy becomes a harbinger of doom. As he tells it, today's economy is the worst since the Great Depression. Without his Recovery and Reinvestment Act, he says, the economy will fall back into that abyss and may never recover.

This fearmongering may be good politics, but it is bad history and bad economics. It is bad history because our current economic woes don't come close to those of the 1930s. At worst, a comparison to the 1981-82 recession might be appropriate. Consider the job losses that Mr. Obama always cites. In the last year, the U.S. economy shed 3.4 million jobs. That's a grim statistic for sure, but represents just 2.2% of the labor force. From November 1981 to October 1982, 2.4 million jobs were lost -- fewer in number than today, but the labor force was smaller. So 1981-82 job losses totaled 2.2% of the labor force, the same as now.

Job losses in the Great Depression were of an entirely different magnitude. In 1930, the economy shed 4.8% of the labor force. In 1931, 6.5%. And then in 1932, another 7.1%. Jobs were being lost at double or triple the rate of 2008-09 or 1981-82.

This was reflected in unemployment rates. The latest survey pegs U.S. unemployment at 7.6%. That's more than three percentage points below the 1982 peak (10.8%) and not even a third of the peak in 1932 (25.2%). You simply can't equate 7.6% unemployment with the Great Depression.

Other economic statistics also dispel any analogy between today's economic woes and the Great Depression. Real gross domestic product (GDP) rose in 2008, despite a bad fourth quarter. The Congressional Budget Office projects a GDP decline of 2% in 2009. That's comparable to 1982, when GDP contracted by 1.9%. It is nothing like 1930, when GDP fell by 9%, or 1931, when GDP contracted by another 8%, or 1932, when it fell yet another 13%.

Auto production last year declined by roughly 25%. That looks good compared to 1932, when production shriveled by 90%. The failure of a couple of dozen banks in 2008 just doesn't compare to over 10,000 bank failures in 1933, or even the 3,000-plus bank (Savings & Loan) failures in 1987-88. Stockholders can take some solace from the fact that the recent stock market debacle doesn't come close to the 90% devaluation of the early 1930s.

Mr. Obama's analogies to the Great Depression are not only historically inaccurate, they're also dangerous. Repeated warnings from the White House about a coming economic apocalypse aren't likely to raise consumer and investor expectations for the future. In fact, they have contributed to the continuing decline in consumer confidence that is restraining a spending pickup. Beyond that, fearmongering can trigger a political stampede to embrace a "recovery" package that delivers a lot less than it promises. A more cool-headed assessment of the economy's woes might produce better policies.

Mr. Schiller, an economics professor at the University of Nevada, Reno, is the author of "The Economy Today" (McGraw-Hill, 2007).

Geithner Lays an Egg

Elections have consequences. That is what democracy is about after all. Barack Obama is correct when he states that his victory last November gives him the right, or more specifically the power, to have things his way when it comes to handling the nation's economic challenges.

The country, moreover, could use some decisive economic action. The financial system is a mess, unemployment is rising and will keep increasing. The government will likely run a deficit of 10 percent or more of GDP both this year and next--roughly twice the share of the Reagan deficits and roughly three times the size of President Bush's deficits. To fight the credit contraction, our central bank is expanding its balance sheet at a pace that might lead a visitor from another planet to confuse the United States with Argentina.

This makes it all the more frustrating that less than a month into his presidency, Obama has made a complete hash of economic policy, utterly squandering his mandate in a series of missteps that suggest he has not made the transition from campaigning to governing. This, even as Obama never stops reminding us in his constant televised appearances that the economy is slipping fast and time is of the essence.

The problems began with the inexplicable decision by the administration not to submit its own economic stimulus package, but instead delegate the job to Nancy Pelosi and the barons on the House Appropriations Committee. Appropriations is the reptilian brain of the political process. It is where all the back scratching, logrolling, and pork barreling gets done. Macroeconomic coherence is just not part of the skill set of House Appropriations members. So even rebuilding the nation's infrastructure got short shrift. Instead, the package was loaded with largesse for fellow politicians and civil service employees back home. The standard was not the proclaimed "shovel-ready" but "social-worker ready."

This package was marginally improved by the House Ways and Means Committee. Ways and Means gave money directly to workers as opposed to local politicians. It also ramped up the various medical spending conduits, which will push more money to health care providers--though not necessarily provide more health care. But there was no improvement in the tax system, which might, say, encourage job creation and retention by lowering the tax burden on employment or investing.

So the package the House produced was not "stimulus" in any normal understanding of the word. Of the $820 billion package that emerged from the House, only 20 percent would be spent in fiscal 2009 and only another 40 percent in 2010. That left 40 percent of the package to be spent in 2011 or later, when even the more pessimistic forecasters (of whom I am one) expect the economy to be in full recovery. This plan delivers the stimulus at precisely the wrong time.

The package was so bad that it made criticism of the new president socially acceptable, a rare development for the first initiative of a president elected with a large mandate. Alice Rivlin, doyenne of Democratic party policy economists, criticized the lack of macroeconomic benefit in the plan. Her sentiments were echoed by just about every leading economist in both parties who was not employed by the administration.

The new administration fell into this hole by belatedly discovering the fiscal realities of the country. Government spending takes time to get going, and, once flowing, is difficult to stop. During the transition, Team Obama surveyed the agencies for "shelf ready" spending needs and found them woefully inadequate as a credible stimulus package. The incoming Obama policy-makers had been focused on spending, not tax cuts, because they wanted to draw a line between themselves and their predecessors. But, faced with the facts, they made a virtue out of necessity by having the president call for taxes to be 40 percent of the package. This annoyed the more left-leaning Democrats of Congress, who were then appeased by being given the power to craft the spending.

The legislation was written by Democratic committee chairmen with no Republican input. The president covered this up by going to the Hill and meeting with the Republican caucus. But, since Obama had no direct role in writing the package, the signal to congressional Republicans was twofold: Bipartisanship was just a façade the president needed to maintain his approval ratings, and Nancy Pelosi and Harry Reid were the ones with the power, not Barack Obama.

The shreds of comity on which Washington depends were saved by Senator Susan Collins of Maine, who drafted a compromise that eliminated some of the most wasteful spending and sped up other parts. The bill that emerged from conference is close to the Collins compromise and is better than the House one at moving spending into the present. The Congressional Budget Office estimates that a quarter of the spending in the conference agreement would leave Washington this year and a total of 75 percent by the end of 2010, a substantial improvement. But it is still not "stimulus," and that fact is going to become apparent later this year. Money leaving Washington for state capitals is different from money actually entering the economy and creating jobs.

The administration released a report by its top economists saying that passage of the stimulus bill would mean that national unemployment would peak in the third quarter of 2009 at about 8 percent and start going down thereafter. Let's just say that we should all hope they are right. The economy will get a pop from the start of stimulus just as the economy got a pop in 2008 from the one-time checks that were sent out. Growth in the second quarter of 2009 is likely to be positive as the first round of stimulus hits the economy. As the rate of new stimulus slows in subsequent quarters, growth will turn negative again. The odds are high that unemployment will still be rising on the first anniversary of the Obama presidency next January with the prospect (but not a certainty) of double-digit unemployment at the time of the midterm elections.

As the stimulus bogged down, a new word crept into the administration's economic policy vocabulary--"comprehensive." The problems would not be easy to solve, and stimulus alone was insufficient. Bank recapitalization and housing mortgage issues would also have to be dealt with. The task for announcing these was delegated to Treasury Secretary Timothy Geithner. But the scripting of the message and indeed the whole "rollout" of the issue was tightly controlled in the West Wing.

Like so much of what happens in Washington, the reasons for this odd locus of decisionmaking authority are less nefarious than meets the eye and more a matter of simple necessity. The first problem is a lack of personnel at Treasury. Geithner is the only confirmed appointee in the department. No deputy secretary, no undersecretaries of either domestic or international finance, no assistant secretaries, no deputy assistant secretaries. The West Wing is the only place where the personnel reside who can make decisions.

The second problem is political. There are no easy answers when facing a trillion-dollar hole in the banking system. Either the banks will fail, or money is going to have to be given to the banks to fill the hole, or the proverbial can will be kicked down the road with enough money being slowly injected into the system to keep it going. The first option is a nonstarter. This brings the essential choice down to writing a big check now to the banks or writing a lot of little checks over time, and bankers are not the most politically sympathetic recipients of federal largesse at the moment.

So there is a political incentive to create a focus on issues that are tangential to the trillion-dollar problem. Make sure that bankers sell their corporate jets! No more bonuses!

The sale of 50 corporate jets in today's market might fetch you $1 billion if you're lucky. End all the bonuses on Wall Street and you get real money--another $18 billion. Put the two together and a $1 trillion problem shrinks to a mere $981 billion one. The administration's hope was that such measures plus the group flogging of the CEOs of the big banks on the Hill last Wednesday would focus the media, Congress, and the public away from the fundamental enormity of the task at hand.

But Geithner still had to say something, and none of the various options available was attractive. Buy the assets from the banks? Set the price high enough to bail out the banks and you have a trillion-dollar overpayment. Set the price at current market prices and you have to come up with the same trillion as a bank capital injection. Do what Bill Seidman and the George H.W. Bush administration did during the S&L crisis by nationalizing the banks and then reselling the pieces into the market? Might work, but while Seidman disposed of the thrift industry by selling them to the basically healthy commercial banks, there aren't any basically healthy banks left on the planet to buy an institution like Citibank or Bank of America. Combined, those two institutions have 14 percent of the deposits in the American banking system, and there are plenty of other banks that need help as well.

The Geithner announcement was repeatedly put off while each of the options was publicly discussed. In the end the political decisionmakers decided there was no politically acceptable decision. But expectations had been building, stoked higher with each postponement of the speech. When Geithner finally spoke and by omission essentially admitted that the Obama administration hadn't come up with a solution, the stock market plummeted.

But it wasn't only the stock prices of America's publicly traded companies that collapsed. So did the stock of the Obama administration. A discredited stimulus package followed by an overly hyped but largely vacuous bank-rescue speech proved to be too much. The mainstream media, which had given Obama a free ride since the election, turned on their choice. In the space of just over three weeks, Obama and company squandered the greatest stock of political capital any president since Lyndon Johnson had inherited from an election.

It is certainly not too late for Obama to create a sensible government policy and assist in an American economic recovery. But he has to stop campaigning and start governing. This means fewer speeches (his strong point, and something he evidently enjoys) and more noodling through wonky decision trees and detailed analyses in concert with expert advisers on both the inside and the outside. All presidents in my experience--and I have served four different administrations--have to learn the difference between campaigning and governing. Obama, whose vita contains lots of campaigning for high offices but remarkably little tenure in such offices, has a bigger challenge than most in making this transition. But he is a smart and well-intentioned fellow. Most important, he has a strong survival instinct. Perhaps he'll sense that unless he makes a rapid transition, he will be a one-term president as the economic catastrophe he warns against so often comes to pass.

Lawrence B. Lindsey, a former governor of the Federal Reserve, was special assistant to President Bush for economic policy and director of the National Economic Council at the White House. His most recent book is What a President Should Know .  .  . but Most Learn Too Late (Rowman and Littlefield).

Obama Levitates

One of many highlights of the stimulus bill the Democrats just rammed through Congress is $8 billion for high-speed rail. What makes this appropriation special is that there was no money for high-speed rail in the original House legislation. The Senate bill had $2 billion. The legislation coming out of conference "compromised" on $8 billion.

How did this happen? Well, some of that $8 billion, as the Washington Post reported Friday, seems intended for "a controversial proposal for a magnetic-levitation rail line between Disneyland, in California, and Las Vegas, a project favored by Senate Majority Leader Harry M. Reid (D-Nev.). The 311-mph train could make the trip from Sin City to Tomorrowland in less than two hours, according to backers." Reid of course played a major role in putting together the final bill.

That's the kind of policymaking the new Obama administration has embraced in its signature legislative proposal: a congressional process as unseemly as ever; an emergency bill that barely addresses the emergency; a "stimulus" bill short on stimulus (is that magnetic-levitation rail line "shovel-ready"?).

What accounts for this debacle? You could start with a lack of presidential leadership. Who would have thought the missing player in the first month of the administration would be Barack Obama? He let his signature economic legislation, the stimulus, be shaped by congressional Democrats. He let internal disputes over the difficult question of how to save the banking system result in a disastrous non-announcement of a non-plan by Treasury Secretary Timothy Geithner last week. Before that, he let Geithner become Treasury secretary after cheating on his income taxes, and waived his own ethics rules to appoint a lobbyist as deputy secretary of defense--undercutting his promises to clean up Washington. He allowed Rahm Emanuel to politicize the Census Bureau, losing as a result his commerce secretary-designee, Judd Gregg, an ornament of his professed hope for bipartisanship.

In foreign policy, Obama has exerted no more control. He allowed both Super-Special Pooh-bah Richard Holbrooke and National Security Adviser Jim Jones to give interviews to the New York Times and the Washington Post, respectively, touting their own importance and presenting the president as a distant player in the formulation of foreign policy. Meanwhile, turf wars in the State Department and the National Security Council are even more bitterly fought than usual. The tale of Holbrooke shouting at Undersecretary of State Bill Burns that he'll keep Burns waiting as long as he wants, since he (allegedly) outranks Burns, makes the Rumsfeld-Powell drama look tame.

And where is Obama amid all this turmoil? Well, he's not amid it--and he's apparently not curbing or directing it. He seems to be magnetically levitating at least a few inches above the ground, doing campaign events in swing states and in his home state of Illinois, revving up the crowds to  .  .  .  do what? To encourage congressional Democrats to support their own package? He allowed the aforementioned Jim Jones--who has a lot on his plate--to spend many hours at an international gabfest in Munich at which Vice President Joe Biden, Deputy Secretary of State James Steinberg, and Holbrooke were already over-representing the United States. Reveling in the fond attentions of the Europeans and occasionally dozing off from jet lag, Jones allowed the delegation to send dangerously ambiguous signals about the U.S. commitment in Afghanistan.

Politically, Republicans are relieved by Obama's weak start. A well-crafted stimulus could have split Hill Republicans. It could also have exposed intellectual disarray on the right over the financial crisis. But Obama allowed the GOP to dodge that bullet and begin the term with a reinvigorating series of intellectually successful assaults on the stimulus bill. A strong message on Afghanistan from the administration would have won the support of Republican hawks--and might have caused other Republicans foolishly to move in a semi-isolationist direction, provoking another internal GOP dispute. Withdrawing Geithner's nomination would have elevated the new president above the last eight years of Republican-dominated Washington business as usual.

So Republicans have some reason to cheer. But not much. The country needs a president capable of exercising leadership at home and abroad. Barack Obama has had a charmed career. He's been the magnetic-levitation train of recent American politics, skimming over the surface at great speed without having to slog through the mud that slows down and climb over the boulders that trip up normal politicians. But now he's president. The charm is wearing off. It's time for him to stoop to govern.

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We Will Not Yield

A rocky first few weeks, By Camille Paglia

Money by the barrelful, by the truckload. Mountains of money, heaped like gassy pyramids in the national dump. Scrounging packs of politicos, snapping, snarling and sending green bills flying sky-high as they root through the tangled mass with ragged claws. The stale hot air filled with cries of rage, the gnashing of teeth and dark prophecies of doom.

Yes, this grotesque scene, like a claustrophobic circle in Dante's "Inferno," was what the U.S. government has looked like for the past two weeks as it fights on over Barack Obama's stimulus package -- a mammoth, chaotic grab bag of treasures, toys and gimcracks. Could popular opinion of our feckless Congress sink any lower? You betcha!
Why in the cosmos would the new administration, smoothly sailing out of Obama's classy inauguration, repeat the embarrassing blunders of Bill Clinton's first term? By foolishly promising a complete overhaul of healthcare within 100 days (and by putting his secretive, ill-prepared wife in charge of it), Clinton made himself look naive and incompetent and set healthcare reform back for more than 15 years.

President Obama was ill-served by his advisors (shall we thump that checkered piñata, Rahm Emanuel?), who evidently did not help him to produce a strong, focused, coherent bill that he could have explained and defended to the nation before it was set upon by partisan wolves. To defer to the House of Representatives and let the bill be thrown together by cacophonous mob rule made the president seem passive and behind the curve.

Most mainstream American voters are undoubtedly suffering from economist fatigue these days. This one calls for tax cuts; that one condemns them. One says we're wasting hundreds of billions of dollars; the other claims that sum falls pathetically short. A plague on all their houses! Surely common sense would dictate that when Congress is doling out fat dollops of taxpayers' money, due time should be delegated for sober consideration and debate. The administration's coercive rush toward instant action, accompanied by apocalyptic pronouncements of imminent catastrophe, has put its own credibility on the line.

But aside from the stimulus muddle, Obama has been off to a good start. True, I was disappointed with the infestation of the new appointments list by Clinton retreads and slippery tax-dodgers. Nevertheless, I was very impressed by Obama's relaxed, natural authority with military officers on Inauguration Day, in contrast to the early Bill Clinton's palpable unease and exaggerated posturing. I applauded the signal Obama sent to the world by starting the closure of the Guantánamo detention center. Contrary to the rote claims of conservative talk radio, there is as yet no public evidence that every individual being held at Guantánamo is a proven "terrorist"-- whom we would all agree should be severely punished. That is the entire point of a rational process of indictment and trial. If Guantánamo became a symbol of un-American repression, it is the procrastinating, paralyzed Bush administration that should be blamed.

Speaking of talk radio (which I listen to constantly), I remain incredulous that any Democrat who professes liberal values would give a moment's thought to supporting a return of the Fairness Doctrine to muzzle conservative shows. (My latest manifesto on this subject appeared in my last column.) The failure of liberals to master the vibrant medium of talk radio remains puzzling. To reach the radio audience (whether the topic is sports, politics or car repair), a host must have populist instincts and use the robust common voice. Too many Democrats have become arrogant elitists, speaking down in snide, condescending tones toward tradition-minded middle Americans whom they stereotype as rubes and buffoons. But the bottom line is that government surveillance of the ideological content of talk radio is a shocking first step toward totalitarianism.

One of the nuggets I've gleaned from several radio sources is that Michigan Sen. Debbie Stabenow, who has been in the aggressive forefront of the campaign to reinstate the Fairness Doctrine, is married to Tom Athans, who works extensively with left-wing radio organizations and was once the executive vice-president of Air America, the liberal radio syndicate that, despite massive publicity from major media, has failed miserably to win a national audience. Stabenow's outrageous conflict of interest has of course been largely ignored by the prestige press, which should have been demanding that she recuse herself from all political involvement with this issue.

Interactive political talk radio is a fabulous American genre (how I miss it when traveling abroad!), but there are other successful radio styles, as demonstrated daily by the BBC World Service, with its exquisitely produced you-are-there reports recorded in streets and cafés or on farms or tundras around the globe. The rich range of regional or class accents (from both inside and outside Great Britain) shown off by BBC commentators is mesmerizing in its own right.

Barack Obama throws Joe Biden under the bus

Pity poor Joe Biden. His "there's still a 30 percent chance we're going to get it wrong" quote is put straight to President Barack Obama during the White House press conference just now and his boss seemed to want to say: "Vice-President Who?"

As reporters started giggling, Obama came close to conceding that Biden was indeed a joke. "You know, I don't remember exactly what Joe was referring to, not surprisingly."

The President went on to say that "I think what Joe may have been suggesting, although I wouldn't ascribe any numerical percentage to any of this, is that given the magnitude of the challenges that we have, any single thing that we do is going to be part of the solution, not all of the solution."

Of course, Biden wasn't saying anything of the sort - Obama knew that and all the rest of us did too.

Biden's exact quote, read out by Fox's Major Garrett at the presser was: "If we do everything right, if we do it with absolute certainty, if we stand up there and we really make the tough decisions, there's still a 30 percent chance we're going to get it wrong."

Clearly, Obama and his aides were unhappy about Biden's loose lips. On Friday, top Obama adviser David Axelrod said on CNN: "I don't know exactly about what that math was."

We're probably going to have to get used to Obama explaining "what Joe may have been suggesting". And Biden must be wondering if he's going to end up as a Dan Quayle figure.

Stimulus: A History of Folly

Before he was sworn in as President, Barack Obama began to lay out his plans for reviving an American economy that, it would later be discovered, had declined 3.8 percent in the fourth quarter of 2008, its worst performance in 26 years. About the first part of his project, “stimulating” businesses to invest and consumers to consume through government spending and tax remittances, he was forthcoming and enthusiastic. About the second, stabilizing the financial system, he wished to reserve judgment.

He anointed the stimulus proposal with a convenient and vivid metaphor. “We’re going to have to jump start this economy with my economic recovery plan,” he said on January 3. According to the image, one can jolt a dormant economy into action just as one can hook up polarized cables to a car battery, clamp a defibrillator to the chest, or breathe into the ear of a reluctant lover. Suddenly, the object of our attention will be back in action, aroused.

Alas, the questions raised by a proposed stimulus—whether to apply it, what sort it should be, how much it should cost, and when it should begin and end—are far trickier to answer than problems involving dead batteries. And, remarkably enough, history and economic research offer no conclusive answers. The recession that began in 2008 could turn out to be the worst slowdown since the Great Depression of the 1930’s. For three-quarters of a century, economists have been studying it diligently. And even now they cannot come to a definitive conclusion about the cause of that depression, the reasons for its severity and duration, or what cured it. In an introduction to a book of essays on the Great Depression he compiled in 2000, Ben S. Bernanke, then a Princeton professor and now chairman of the Federal Reserve Board, wrote, “Finding an explanation for the worldwide economic collapse of the 1930’s remains a fascinating intellectual challenge.”

Today, of course, the challenge is more than intellectual.

_____________

When he wrote in 1936 that “practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist,” John Maynard Keynes surely did not have himself in mind. But, in times of trouble, Americans still cling to Keynes, or at least to the caricature of him as the economist who said you could spend your way out of a recession. His big idea was that, left to its own devices, an economy can fall into a slump and just stay there. Self-corrective mechanisms will not necessarily work on their own; they will need help.

Prosperity depends on investment, on businesses building new plants, buying new machines, and employing more workers. In a typical case, when an economy slows, businesses reduce their demand for credit. At the same time, worried consumers save their earnings in banks, and by doing so, add to the store of money available for lending. These two forces—as well as actions taken by the Federal Reserve Board—combine to push interest rates to levels so attractive that businesses start borrowing again, and the economy picks up. The Great Depression, however, was atypical. The economy slowed and interest rates fell, but businesses were so frightened about the future that they refused to invest; instead, they did the opposite, shutting plants and firing workers. As for consumers, while they may have wanted to save, they lacked the cash to put away. Because they were out of work, they depleted what savings they had.

Keynes argued that, when businesses and people cannot or will not invest, then the government must take on the role of filling the gap. The key is speed. The means, Keynes wrote in The General Theory of Employment, Interest and Money, really did not matter so much:

If the Treasury were to fill old bottles with bank notes, bury them at suitable depths in disused coal mines which are then filled to the surface with town rubbish and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again, . . . there need be no more unemployment and with the help of the repercussions, the real income of the community would probably become a good deal larger than it is.

Of course, Keynes favored large public-works projects over the burying of bottles. Building roads in the right places, for example, would both put people to work and provide the basis for more commerce. At first, Keynes emphasized government spending as stimulus, but, when pressed in 1933, he advocated tax cuts as well—specifically in response to criticism that public-works projects do not put cash into the system quickly enough.

The dire situation for which Keynes prescribed a cure bears distressing similarities to our own. Interest rates set by the Fed stand effectively at zero percent, but banks are recalcitrant about lending and even businesses flush with cash are hesitant to invest. It appears that the current sickness occurred because the Fed, in an effort to keep the economy stimulated after the collapse of the tech-stock bubble and in the wake of September 11, cut interest rates far too much during 2001 (from 6.5 percent at the start of the year to 1.75 percent at the end) and waited too long to raise them, making credit so easy that businesses expanded beyond all reasonable bounds, and banks, flush with cash and trying to make higher returns, shoveled money at borrowers with poor credit; risk aversion disappeared, and loans, especially to home buyers, went bad. Booms do, after all, create their own busts.

In response, Congress last year voted funds for the Treasury to use to shore up financial institutions—the widely maligned Troubled Asset Relief Program, or TARP—and the Fed opened wide its lending window. Those actions forestalled mass failures, but banks, chastened by their past overindulgence and worried about depleting their capital, still do not want to lend. So while government action proved necessary (and remains necessary) to maintain public confidence in the banking system, it became clear those actions could not and would not mitigate the parlous effects of the recession that, we were told late in 2008, had begun at the end of 2007. So the question becomes: In a world in which monetary adjustments do not appear effective, can tax and spending policies pull us out of the slump?

_____________

The track record is discouraging. Despite Franklin Roosevelt’s aggressive spending, unemployment reached 25 percent in 1933, fell only to 14 percent by 1937, and was back up to 19 percent in 1939.¹ In the end, the New Deal did little or nothing to resuscitate the economy. Certainly, inept monetary policies helped prolong the Great Depression, as did tax increases, constant interventions in the conduct of business, and the erection of global trade barriers, beginning with the Smoot-Hawley Tariff in 1930, more than two years before Roosevelt took office. There was a stretch of twelve years from the stock-market crash to Pearl Harbor, and, during that time, fiscal stimulus simply did not jump-start the economy (or, in Keynes’s own metaphor, “awaken Sleeping Beauty”). Now, some do attempt to make the case that Roosevelt did not increase government spending enough during the early and mid-1930’s and that it took World War II and the unprecedented infusion of government dollars into the economy to provide the stimulus that finally pulled America from the swamp.

But even if that were true—and considering the fact that federal spending tripled during the Great Depression, rising from 3 percent of the country’s gross domestic product to nearly 10 percent in 1939,² it does not seem the likeliest explanation—it still does not offer much in the way of guidance through our current thicket. Few economists today believe the United States could tolerate the kind of budget deficits that developed during World War II, which ran more than 50 percent of gross domestic product, or about $7 trillion annually in current terms. When the federal government ramped up its spending during the war, it had not yet grown into the entitlement cash machine it is now, spitting out trillions of dollars a year in retirement and health-care benefits.

Not only was the stimulative effect of Great Depression fiscal policy non-existent, but follow-on efforts during the ten subsequent recessions proved equally ineffective. As a result of that hard-won experience, the consensus until recently among economists was that attempts at stimulus through emergency fiscal policies—as opposed to monetary policies and the automatic effects of increases in unemployment assistance and decreases in tax payments—were useless at best. Typical was the statement of Martin Eichenbaum of Northwestern University in the American Economic Review in 1997: “There is now widespread agreement that countercyclical discretionary fiscal policy is neither desirable nor politically feasible.” Martin Feldstein, then president of the National Bureau of Economic Research, agreed. Fiscal stimulus, he said in 2002, “has not contributed to economic stability and may have actually been destabilizing.”

_____________

A good place to turn to understand the failure of the jump-start is the work of Frederic Bastiat, a French politician of the early 19th century. “In the economic sphere,” he wrote,

an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.

To prove his point, Bastiat described what happens when a vandal breaks a shopkeeper’s window. The seen effect is that repairing the glass creates economic value in the payment to the glazier, who then has money to buy a new suit or hire a part-time employee. What is unseen is that the shopkeeper has to pay the glazier with money that he would otherwise have used to buy a suit or add an employee. “The broken-window fallacy, under a hundred disguises, is the most persistent in the history of economics,” wrote the economic journalist Henry Hazlitt in 1946.

Like payments for broken windows, tax rebates and new roads (the seen) do not come free. The stimulus money that flows to taxpayers, government agencies, and businesses has to come from somewhere (the unseen). During a recession, it is usually borrowed, and the anticipation of taxpayers is that they will have to repay these loans, which means their taxes will rise in the future. This knowledge makes people anxious about spending the extra money, or even about investing it in the kind of ventures that help an economy grow.³

Lately, however, economists have become more sanguine about the power of fiscal stimulus, in large part because of the apparent success of the tax-rate reductions and rebates in 2001 and 2003 (although such a conclusion may ignore the monetary effects of the huge cut in interest rates). A summary of a conference held in May by the Federal Reserve Bank of San Francisco stated that “the consensus” against stimulus “has unraveled and perhaps even begun to emerge on the opposite viewpoint.” Last year, Jason Furman and Douglas Elmendorf of the Brookings Institution wrote, “Fiscal policy implemented promptly can provide a larger near-term impetus to economic policy than monetary policy can.” And, in a paper delivered to the American Economic Association in January, Feldstein himself switched sides and said he now favored tax cuts and government spending.

The views of these economists are undoubtedly heartfelt, but it must be recognized that one of the great attractions of Keynes’s theories is that he gives you permission to do what you wanted to do anyway. Feldstein, chairman of the Council of Economic Advisors under Ronald Reagan, proposes a stimulus policy that extends the Bush tax cuts currently scheduled to expire in 2011 and increases spending on defense and national intelligence. In their stimulus proposal, Furman, now deputy director of Obama’s National Economic Council, and Elmendorf, head of the Congressional Budget Office under the current Democratic majority, adamantly oppose extending the Bush cuts and instead want to extend unemployment and Food Stamp benefits and issue short-term tax credits, even to people who owe no taxes.

Also, in the new enthusiasm for stimulus, there is not a small degree of panic; monetary policy is not working, so fiscal policy must! To his credit, however, Feldstein writes toward the end of his January paper, “It is of course possible that the planned surge in government spending will fail. Two or three years from now we could be facing a level of unemployment that is higher than today and that shows no sign of coming down.”

The truth is that we have learned almost nothing about the use of fiscal stimulus since the Great Depression, and it is a fatal conceit to assume that we can hurriedly construct a fiscal policy that will produce the prescribed results today. Economists seem to admit this fact by advocating what they prefer anyway, for political or ideological reasons. I would feel better about stimulus if Elmendorf were clamoring for permanent tax cuts and Feldstein food stamps.

_____________

On being presented the Nobel Prize in economics in 1974, Friedrich von Hayek devoted his Stockholm lecture to acknowledging the severe limitations of his profession. “It seems to me,” he said, “that this failure of the economists to guide policy more successfully is closely connected with their propensity to imitate as closely as possible the procedures of the brilliantly successful physical sciences—an attempt which in our field may lead to outright error.” Government simply cannot know enough to direct an economy successfully, and when the President claims that his fiscal stimulus plan will create (or save) at least three million jobs, he is taking a wild, and dangerous, leap. Said Hayek:

If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.

What is that environment? First, it provides a confidence that, in a crisis, bank deposits are safe and insurance policies will be paid in full. Such confidence can be provided only by the government of the United States in its legitimate and essential role as the lender of last resort. Second, the environment supports, rather than denigrates or browbeats, productive members of society. The U.S. will not emerge from a serious recession unless businesses and investors lead it out. Third, it recognizes that Americans have undergone a financial calamity and that we need time to adjust; we cannot, like a car battery, be shocked back to life, and we aren’t in the mood to have someone blow in our ear.

In fact, stimulus may be precisely the wrong metaphor. Rather than getting jazzed up, we need to be calmed down and to take the time to learn from the Great Depression, a time when government did too much, not too little. Amity Shlaes makes the argument in The Forgotten Man, her book about the Great Depression, that the constant experimenting and meddling of the New Deal froze investors and business operators in fear: “Businesses decided to wait Roosevelt out, hold on to their cash, and invest in future years.”

Despite the warnings of Keynes, the experience of the past half-century indicates that today’s low interest rates will start having a positive effect, though it still will take many months. Meanwhile, left alone, what Hayek called “spontaneous order” will find its way forward. Using a different metaphor, James Grant, in his history of credit, Money of the Mind, wrote, “The cycle of decay and renewal is as much a part of capitalism as it is of the forest floor.” But, in the 1930’s, “something in the normal regenerative process was missing. There was no decisive recovery from the business-cycle bottom. People had lost their speculative courage, and the more government legislated and taxed, the more that credit sulked.”

Stimulus—that is, fiscal intervention with the express purpose of speeding up the normal regenerative process that Grant describes—is unnecessary and almost certainly harmful, a policy based on hubris and anxiety, rather than on history and good sense. Under such circumstances, the proper way to analyze discrete proposals today for spending or taxing is on their own merits, not on their supposed ability to stimulate something else. There may, in fact, be a good reason for government to spend billions of dollars today on building highways, and it has nothing to do with stimulus. It is that long-term interest rates are at historic lows and that the right highways can boost the economy in the long term. There also may be a good reason, again far apart from stimulus, for revising the tax code and reforming Social Security and Medicare. It is that Americans now understand that the economic future is not so assured as they believed a couple of years ago, and it is time for decisions to be made—in a manner careful, sensible, and unstimulated.

Why Obama’s new Tarp will fail to rescue the banks. Has Barack Obama’s presidency already failed?

Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much. If he fails to act decisively, the president risks being overwhelmed, like his predecessor. The costs to the US and the world of another failed presidency do not bear contemplating.

What is needed? The answer is: focus and ferocity. If Mr Obama does not fix this crisis, all he hopes from his presidency will be lost. If he does, he can reshape the agenda. Hoping for the best is foolish. He should expect the worst and act accordingly.

Yet hoping for the best is what one sees in the stimulus programme and – so far as I can judge from Tuesday’s sketchy announcement by Tim Geithner, Treasury secretary – also in the new plans for fixing the banking system. I commented on the former last week. I would merely add that it is extraordinary that a popular new president, confronting a once-in-80-years’ economic crisis, has let Congress shape the outcome.

The banking programme seems to be yet another child of the failed interventions of the past one and a half years: optimistic and indecisive. If this “progeny of the troubled asset relief programme” fails, Mr Obama’s credibility will be ruined. Now is the time for action that seems close to certain to resolve the problem; this, however, does not seem to be it.

All along two contrasting views have been held on what ails the financial system. The first is that this is essentially a panic. The second is that this is a problem of insolvency.

Under the first view, the prices of a defined set of “toxic assets” have been driven below their long-run value and in some cases have become impossible to sell. The solution, many suggest, is for governments to make a market, buy assets or insure banks against losses. This was the rationale for the original Tarp and the “super-SIV (special investment vehicle)” proposed by Henry (Hank) Paulson, the previous Treasury secretary, in 2007.

Under the second view, a sizeable proportion of financial institutions are insolvent: their assets are, under plausible assumptions, worth less than their liabilities. The International Monetary Fund argues that potential losses on US-originated credit assets alone are now $2,200bn (€1,700bn, £1,500bn), up from $1,400bn just last October. This is almost identical to the latest estimates from Goldman Sachs. In recent comments to the Financial Times, Nouriel Roubini of RGE Monitor and the Stern School of New York University estimates peak losses on US-generated assets at $3,600bn. Fortunately for the US, half of these losses will fall abroad. But, the rest of the world will strike back: as the world economy implodes, huge losses abroad – on sovereign, housing and corporate debt – will surely fall on US institutions, with dire effects.

Personally, I have little doubt that the second view is correct and, as the world economy deteriorates, will become ever more so. But this is not the heart of the matter. That is whether, in the presence of such uncertainty, it can be right to base policy on hoping for the best. The answer is clear: rational policymakers must assume the worst. If this proved pessimistic, they would end up with an over-capitalised financial system. If the optimistic choice turned out to be wrong, they would have zombie banks and a discredited government. This choice is surely a “no brainer”.

The new plan seems to make sense if and only if the principal problem is illiquidity. Offering guarantees and buying some portion of the toxic assets, while limiting new capital injections to less than the $350bn left in the Tarp, cannot deal with the insolvency problem identified by informed observers. Indeed, any toxic asset purchase or guarantee programme must be an ineffective, inefficient and inequitable way to rescue inadequately capitalised financial institutions: ineffective, because the government must buy vast amounts of doubtful assets at excessive prices or provide over-generous guarantees, to render insolvent banks solvent; inefficient, because big capital injections or conversion of debt into equity are better ways to recapitalise banks; and inequitable, because big subsidies would go to failed institutions and private buyers of bad assets.

Why then is the administration making what appears to be a blunder? It may be that it is hoping for the best. But it also seems it has set itself the wrong question. It has not asked what needs to be done to be sure of a solution. It has asked itself, instead, what is the best it can do given three arbitrary, self-imposed constraints: no nationalisation; no losses for bondholders; and no more money from Congress. Yet why does a new administration, confronting a huge crisis, not try to change the terms of debate? This timidity is depressing. Trying to make up for this mistake by imposing pettifogging conditions on assisted institutions is more likely to compound the error than to reduce it.

Assume that the problem is insolvency and the modest market value of US commercial banks (about $400bn) derives from government support (see charts). Assume, too, that it is impossible to raise large amounts of private capital today. Then there has to be recapitalisation in one of the two ways indicated above. Both have disadvantages: government recapitalisation is a bail-out of creditors and involves temporary state administration; debt-for-equity swaps would damage bond markets, insurance companies and pension funds. But the choice is inescapable.

If Mr Geithner or Lawrence Summers, head of the national economic council, were advising the US as a foreign country, they would point this out, brutally. Dominique Strauss-Kahn, IMF managing director, said the same thing, very gently, in Malaysia last Saturday.

The correct advice remains the one the US gave the Japanese and others during the 1990s: admit reality, restructure banks and, above all, slay zombie institutions at once. It is an important, but secondary, question whether the right answer is to create new “good banks”, leaving old bad banks to perish, as my colleague, Willem Buiter, recommends, or new “bad banks”, leaving cleansed old banks to survive. I also am inclined to the former, because the culture of the old banks seems so toxic.

By asking the wrong question, Mr Obama is taking a huge gamble. He should have resolved to cleanse these Augean banking stables. He needs to rethink, if it is not already too late.

martin.wolf@ft.com

How Government Created the Financial Crisis

By JOHN B. TAYLOR

Many are calling for a 9/11-type commission to investigate the financial crisis. Any such investigation should not rule out government itself as a major culprit. My research shows that government actions and interventions -- not any inherent failure or instability of the private economy -- caused, prolonged and dramatically worsened the crisis.

David Gothard

The classic explanation of financial crises is that they are caused by excesses -- frequently monetary excesses -- which lead to a boom and an inevitable bust. This crisis was no different: A housing boom followed by a bust led to defaults, the implosion of mortgages and mortgage-related securities at financial institutions, and resulting financial turmoil.

Monetary excesses were the main cause of the boom. The Fed held its target interest rate, especially in 2003-2005, well below known monetary guidelines that say what good policy should be based on historical experience. Keeping interest rates on the track that worked well in the past two decades, rather than keeping rates so low, would have prevented the boom and the bust. Researchers at the Organization for Economic Cooperation and Development have provided corroborating evidence from other countries: The greater the degree of monetary excess in a country, the larger was the housing boom.

The effects of the boom and bust were amplified by several complicating factors including the use of subprime and adjustable-rate mortgages, which led to excessive risk taking. There is also evidence the excessive risk taking was encouraged by the excessively low interest rates. Delinquency rates and foreclosure rates are inversely related to housing price inflation. These rates declined rapidly during the years housing prices rose rapidly, likely throwing mortgage underwriting programs off track and misleading many people.

Adjustable-rate, subprime and other mortgages were packed into mortgage-backed securities of great complexity. Rating agencies underestimated the risk of these securities, either because of a lack of competition, poor accountability, or most likely the inherent difficulty in assessing risk due to the complexity.

Other government actions were at play: The government-sponsored enterprises Fannie Mae and Freddie Mac were encouraged to expand and buy mortgage-backed securities, including those formed with the risky subprime mortgages.

Government action also helped prolong the crisis. Consider that the financial crisis became acute on Aug. 9 and 10, 2007, when money-market interest rates rose dramatically. Interest rate spreads, such as the difference between three-month and overnight interbank loans, jumped to unprecedented levels.

Diagnosing the reason for this sudden increase was essential for determining what type of policy response was appropriate. If liquidity was the problem, then providing more liquidity by making borrowing easier at the Federal Reserve discount window, or opening new windows or facilities, would be appropriate. But if counterparty risk was behind the sudden rise in money-market interest rates, then a direct focus on the quality and transparency of the bank's balance sheets would be appropriate.

Early on, policy makers misdiagnosed the crisis as one of liquidity, and prescribed the wrong treatment.

To provide more liquidity, the Fed created the Term Auction Facility (TAF) in December 2007. Its main aim was to reduce interest rate spreads in the money markets and increase the flow of credit. But the TAF did not seem to make much difference. If the reason for the spread was counterparty risk as distinct from liquidity, this is not surprising.

Another early policy response was the Economic Stimulus Act of 2008, passed in February. The major part of this package was to send cash totaling over $100 billion to individuals and families so they would have more to spend and thus jump-start consumption and the economy. But people spent little if anything of the temporary rebate (as predicted by Milton Friedman's permanent income theory, which holds that temporary as distinct from permanent increases in income do not lead to significant increases in consumption). Consumption was not jump-started.

A third policy response was the very sharp reduction in the target federal-funds rate to 2% in April 2008 from 5.25% in August 2007. This was sharper than monetary guidelines such as my own Taylor Rule would prescribe. The most noticeable effect of this rate cut was a sharp depreciation of the dollar and a large increase in oil prices. After the start of the crisis, oil prices doubled to over $140 in July 2008, before plummeting back down as expectations of world economic growth declined. But by then the damage of the high oil prices had been done.

After a year of such mistaken prescriptions, the crisis suddenly worsened in September and October 2008. We experienced a serious credit crunch, seriously weakening an economy already suffering from the lingering impact of the oil price hike and housing bust.

Many have argued that the reason for this bad turn was the government's decision not to prevent the bankruptcy of Lehman Brothers over the weekend of Sept. 13 and 14. A study of this event suggests that the answer is more complicated and lay elsewhere.

While interest rate spreads increased slightly on Monday, Sept. 15, they stayed in the range observed during the previous year, and remained in that range through the rest of the week. On Friday, Sept. 19, the Treasury announced a rescue package, though not its size or the details. Over the weekend the package was put together, and on Tuesday, Sept. 23, Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson testified before the Senate Banking Committee. They introduced the Troubled Asset Relief Program (TARP), saying that it would be $700 billion in size. A short draft of legislation was provided, with no mention of oversight and few restrictions on the use of the funds.

The two men were questioned intensely and the reaction was quite negative, judging by the large volume of critical mail received by many members of Congress. It was following this testimony that one really begins to see the crisis deepening and interest rate spreads widening.

The realization by the public that the government's intervention plan had not been fully thought through, and the official story that the economy was tanking, likely led to the panic seen in the next few weeks. And this was likely amplified by the ad hoc decisions to support some financial institutions and not others and unclear, seemingly fear-based explanations of programs to address the crisis. What was the rationale for intervening with Bear Stearns, then not with Lehman, and then again with AIG? What would guide the operations of the TARP?

It did not have to be this way. To prevent misguided actions in the future, it is urgent that we return to sound principles of monetary policy, basing government interventions on clearly stated diagnoses and predictable frameworks for government actions.

Massive responses with little explanation will probably make things worse. That is the lesson from this crisis so far.

Mr. Taylor, a professor of economics at Stanford and a senior fellow at the Hoover Institution, is the author of "Getting Off Track: How Government Actions and Interventions Caused, Prolonged and Worsened the Financial Crisis," published later this month by Hoover Press.

The Return of Welfare As We Knew It. The House stimulus bill endangers Clinton's biggest reform.

Twelve years ago, President Bill Clinton signed a law that he correctly proclaimed would end "welfare as we know it." That sweeping legislation, the Personal Responsibility and Work Opportunity Act, eliminated the open-ended entitlement that had existed since 1965, replacing it with a finite, block grant approach called the Temporary Assistance to Needy Families (TANF) program.

TANF has been a remarkable success. Welfare caseloads nationally fell from 12.6 million in 1997 to fewer than five million in 2007. And yet despite this achievement, House Democrats are seeking to undo Mr. Clinton's reforms under the cover of the stimulus bill.

Currently, welfare recipients are limited to a total of five years of federal benefits over a lifetime. They're also required to begin working after two years of government support. States are accountable for helping their needy citizens transition from handouts to self-sufficiency. Critically, the funds provided to states are fixed appropriations by the federal government.

Through a little noticed provision of the stimulus package that has passed the House of Representatives, the bill creates a fund for TANF that is open-ended -- the same way Medicare and Social Security are.

In the section of the House bill dealing with cash assistance to low-income families, the authors inserted the bombshell phrase: "such sums as are necessary." This is a profound departure from the current statutory scheme, despite the fact that, in this particular bill, state TANF spending would be capped. The "such sums" appropriation language is deliberately obscure. It is a camel's nose provision intended to reverse Clinton-era legislation and create a new template for future TANF reauthorizations.

Most liberals have always disliked welfare reform; critics of TANF believed Mr. Clinton supported it only to get re-elected. Some asserted it was racist or intended to punish the poor. Others claimed that the funds to assist single mothers with child care, transportation and job training were never as generous as were allegedly promised. Today, the fact that disqualification from the program is based on failing to secure a job within two years seems especially harsh given this economic crisis.

There are legitimate objections to the program that are worth debating. But this is not an open debate: It is a near secret provision buried deep in a more than 600-page piece of legislation.

The TANF provisions of the stimulus bill, like the nearly $100 billion Medicaid provisions, are less about stimulating the economy, and more about the federal government absorbing the states' budget problems. State budgets may be swamped with those needing temporary relief, and a contingency fund could help. But it should be a definite amount, not a precedent-setting, open-ended amount. (If the initial TANF allocation is not sufficient, Congress could appropriate another definite amount.)

The offending language is not in yesterday's Senate version of the bill, but that provides little comfort. The attempt to undo welfare reform has not been transparent, and the conference committee provides the perfect closed-door environment for slipping in "such sums" language into the final bill without public scrutiny.

Welfare reform was arguably the most important legislative development of the mid-1990s. It is bad policy to jettison it with five words during an economic crisis.

All who are concerned about our nation's unfunded obligations should be on guard against attempts to slip "such sums" language into any conference committee bill. Welfare policy is too important to change with a stealth maneuver.

Mr. Sasse, former U.S. assistant secretary of Health and Human services, teaches policy at the University of Texas. Mr. Weems, former vice chairman of the American Health Information Community, held the position of administrator of the Centers for Medicare and Medicaid services until last month.

Why Obama Wants Control of the Census. Counting citizens is a powerful political tool.

President Obama said in his inaugural address that he planned to "restore science to its rightful place" in government. That's a worthy goal. But statisticians at the Commerce Department didn't think it would mean having the director of next year's Census report directly to the White House rather than to the Commerce secretary, as is customary. "There's only one reason to have that high level of White House involvement," a career professional at the Census Bureau tells me. "And it's called politics, not science."

The decision was made last week after California Rep. Barbara Lee, chair of the Congressional Black Caucus, and Hispanic groups complained to the White House that Judd Gregg, the Republican senator from New Hampshire slated to head Commerce, couldn't be trusted to conduct a complete Census. The National Association of Latino Officials said it had "serious questions about his willingness to ensure that the 2010 Census produces the most accurate possible count."

Anything that threatens the integrity of the Census has profound implications. Not only is it the basis for congressional redistricting, it provides the raw data by which government spending is allocated on everything from roads to schools. The Bureau of Labor Statistics also uses the Census to prepare the economic data that so much of business relies upon. "If the original numbers aren't as hard as possible, the uses they're put to get fuzzier and fuzzier," says Bruce Chapman, who was director of the Census in the 1980s.

Mr. Chapman worries about a revival of the effort led by minority groups after the 2000 Census to adjust the totals for states and cities using statistical sampling and computer models. In 1999, the Supreme Court ruled 5-4 in Department of Commerce v. U.S. House that sampling could not be used to reapportion congressional seats. But it left open the possibility that sampling could be used to redraw political boundaries within the states.

Such a move would prove controversial. "Sampling potentially has the kind of margin of error an opinion poll has and the same subjectivity a voter-intent standard in a recount has," says Mr. Chapman.

Starting in 2000, the Census Bureau conducted three years of studies with the help of many outside statistical experts. According to then Census director Louis Kincannon, the Bureau concluded that "adjustment based on sampling didn't produce improved figures" and could damage Census credibility.

The reason? In theory, statisticians can identify general numbers of people missed in a head count. But it cannot then place those abstract "missing people" into specific neighborhoods, let alone blocks. And anyone could go door to door and find out such people don't exist. There can be other anomalies. "The adjusted numbers told us the head count had overcounted the number of Indians on reservations," Mr. Kincannon told me. "That made no sense."

The problem of counting minorities and the homeless has long been known. Census Bureau statisticians believe that a vigorous hard count, supplemented by adding in the names of actual people missed by head counters but still found in public records, is likely to lead to a far more defensible count than sampling-based adjustment.

The larger debate prompted seven former Census directors -- serving every president from Nixon to George W. Bush -- to sign a letter last year supporting a bill to turn the Census Bureau into an independent agency after the 2010 Census. "It is vitally important that the American public have confidence that the census results have been produced by an independent, non-partisan, apolitical, and scientific Census Bureau," it read.

The directors also noted that "each of us experienced times when we could have made much more timely and thorough responses to Congressional requests and oversight if we had dealt directly with Congress." The bill's chief sponsor is New York Democratic Rep. Carolyn Maloney, who represents Manhattan's Upper East Side.

"The real issue is who directs the Census, the pros or the pols," says Mr. Chapman. "You would think an administration that's thumping its chest about respecting science would show a little respect for scientists in the statistical field." He worries that a Census director reporting to a hyperpartisan such as White House Chief of Staff Rahm Emanuel increases the chances of a presidential order that would override the consensus of statisticians.

The Obama administration is downplaying how closely the White House will oversee the Census Bureau. But Press Secretary Robert Gibbs insists there is "historical precedent" for the Census director to be "working closely with the White House."

It would be nice to know what Sen. Gregg thinks about all this, but he's refusing comment. And that, says Mr. Chapman, the former Census director, is damaging his credibility. "He will look neutered with oversight of the most important function of his department over the next two years shipped over to the West Wing," he says. "If I were him, I wouldn't take the job unless I had that changed."

Mr. Fund is a columnist for WSJ.com.

The Missing Obama Tax Cut. He promised to eliminate the capital-gains tax for small businesses.

One question we wish someone had asked President Obama at last night's press conference is this: Why doesn't his economic stimulus bill include his own campaign proposal to eliminate the capital-gains tax for small businesses? The House bill omits it entirely, and the Senate version offers a rate reduction to 7% from the current 14%, but only on investments made in the next two years. That lower rate would apply to less than 2% of all capital gains.

Barack Obama breaks his campaign promise to cut capital-gains taxes for small business. Senior economics writer Stephen Moore explains. (Feb. 10)

Mr. Obama's original promise to cancel the capital gains tax for small enterprises was highlighted on his campaign Web site under "Small Business Emergency Rescue Plan." A few weeks before the election, advisers Austan Goolsbee and Jason Furman touted their boss's pro-growth credentials by noting in this newspaper that "he is proposing additional tax cuts" that included "the elimination of capital gains taxes for small businesses and start-ups."

The revenue loss would be minimal, especially as compared to the rest of the $800 billion spend-a-thon, because any untaxed gains would only be realized well into the future. We'd prefer an across-the-board capital gains cut rather than a targeted reduction. But the proposal would at least signal some Democratic interest in encouraging businesses to take risks again -- the only way the economy is going to recover.

So what happened? We're told the obstacle is House Democrats, who oppose any cut in capital gains tax rates. The objection seems to be wholly ideological, a concern that such a cut -- even for start-ups, rather than for current capital holdings -- would validate Republican tax-cutters. The White House decided not to fight Democrats to add the President's own pro-growth idea to a bill whose supposed purpose is to promote growth. This looks like an early example of Mr. Obama repeating a mistake that President Bush made too often -- refusing to challenge a Congress run by his own party.

There's No Stimulus Free Lunch. It's hard to spend wise and spend fast.

How much will the stimulus package moving in Congress really stimulate the economy?

The evaluations to date have been incomplete, so we looked at the likely stimulative effect from the spending parts of the House and Senate bills -- over $500 billion -- and assessed the quantitative effects of four basic factors.

Corbis

1) How much increase in Gross Domestic Product (GDP) can be expected from the stimulus package?

In a full-employment situation, increased government spending would largely replace private spending, so the net stimulus to GDP would likely be quite small. In the present environment, however, with growing unemployment of both labor and capital, the net stimulus would be larger since the additional government spending would put some unemployed resources to work.

For example, if the government spent money to build new homes with unemployed labor, the stimulus to GDP might be close to, even larger than, the amount spent. However, given the present housing glut, that hardly seems to be a wise policy, although it is a small part of both the House and Senate stimulus packages.

In fact, much of the proposed spending would be in sectors and on programs where the government would mainly have to draw resources away from other uses. This type of spending includes adding broadband to rural areas, spending more on health coverage, encouraging scientific innovations, developing renewable energy, as well as many other things.

As President Barack Obama recently said, "This plan is more than a prescription for short-term spending -- it's a strategy for America's long-term growth and opportunity in areas such as renewable energy, health care and education." Such spending may encourage long-term growth, but it will have little short-term effect on GDP.

So our conclusion is that the net stimulus to short-term GDP will not be zero, and will be positive, but the stimulus is likely to be modest in magnitude. Some economists have assumed that every $1 billion spent by the government through the stimulus package would raise short-term GDP by $1.5 billion. Or, in economics jargon, that the multiplier is 1.5.

That seems too optimistic given the nature of the spending programs being proposed. We believe a multiplier well below one seems much more likely.

2) The increased government spending in the stimulus package is supposed to be only temporary, until the economy returns to a full employment level, but probably won't be.

The evidence of past expansions of government programs is just the opposite. Once created they tend to survive and grow over time, even when the increases initially were said to be temporary. The underlying reason for this is that interest groups develop around new and expanded programs, and they lobby to keep and expand those programs.

This implies that the spending programs in the stimulus package will continue to some extent after the economy has returned to full employment. The multiplier at that time will surely be much closer to zero. Looking several years ahead, then, the average stimulus from the expansion in government spending will be smaller, perhaps much smaller, than the short-term stimulus.

3) The effects on consumers and businesses of the stimulus package depend not only on the stimulus to short-term GDP, but also on how valuable the spending is.

Whatever the merits of other government spending, the spending in this package is likely to have less value. A very large amount of money will be spent quickly over a two-year period: $500 billion amounts to about one-quarter of the total federal government annual spending of $2 trillion. It is extremely difficult for any group, private as well as public, to spend such a large sum wisely in a short period of time.

In addition, although politics play an important part in determining all government spending, political considerations are especially important in a spending package adopted quickly while the economy is reeling, and just after a popular president took office. Many Democrats saw the stimulus bill as a golden opportunity to enact spending items they've long desired. For this reason, various components of the package are unlikely to pass any reasonably stringent cost-benefit test.

4) There are no free lunches in spending, public or private.

The increased federal debt caused by this stimulus package has to be paid for eventually by higher taxes on households and businesses. Higher income and business taxes generally discourage effort and investments, and result in a larger social burden than the actual level of the tax revenue needed to finance the greater debt. The burden from higher taxes down the road has to be deducted both from any short-term stimulus provided by the spending program, and from its long-run effects on the economy.

We believe that it is incumbent on both supporters and opponents of the bill to thoughtfully evaluate each of these four factors. We recognize that how individuals will come out in their own evaluation of these factors will determine their attitude toward the stimulus package, and that there is considerable ground for reasonable differences of opinion.

Our own view is that the short-term stimulus from the legislation before Congress will be smaller per dollar spent than is expected by many others because the package tries to combine short-term stimulus with long-term benefits to the economy. Unfortunately, short-term and long-term gains are in considerable conflict with each other. Moreover, it is very hard to spend wisely large sums in short periods of time. Nor can one ever forget that spending is not free, and ultimately it has to be financed by higher taxes.

Mr. Becker, the 1992 Nobel economics laureate, is professor of economics at the University of Chicago and senior fellow at the Hoover Institution. Mr. Murphy, a MacArthur Fellow, is an economics professor at the University of Chicago and a senior fellow at the Hoover Institution.