There are three urgent economic problems that need to be addressed by policy: (1) The bursting of the housing bubble and the subsequent and continuing fall in housing prices. (2) The credit crisis, which resulted from the bursting of the housing bubble. And (3) the fall in aggregate demand, which resulted from the bursting of the housing bubble and the credit crisis. The prime mover was (1), but the real problem—the reason (1) and (2) are problems at all—is (3), since (3) is what causes recessions.

The science of economics has developed to a point where there’s not a lot of controversy over what types of remedy are required for each problem. For the fall in housing prices, the policy response would be loan modifications that stem the tide of foreclosures. For the credit crisis, the remedy is injection of capital into banks. And for a fall in aggregate demand, the preferred solution is monetary expansion, which, in contrast to fiscal policy, is quickly implemented, operates over the economy as a whole, and yields quick results. And if monetary expansion is unavailable—as is the case now, with the Federal Funds rate (the rate the Fed controls) at 1 percent—the indicated action is a fiscal stimulus.

Nearly all economists, conservative or liberal, agree on the latter point. Martin Feldstein—Chairman of President Reagan’s Council of Economic Advisors and a McCain supporter—for example, writes in a recent op-ed, "With the Fed’s benchmark interest rate down to 1 percent, there is no scope for an easier monetary policy to stop the downward spiral in aggregate demand…. The only way to prevent a deepening recession will be a temporary program of increased government spending" (Washington Post, 10/30/2008). This view is widespread. A group of 387 economists, including Nobel Laureates George Akerlof, Robert Solow and Joseph Stiglitz, signed a letter, dated November 19^th, urging congressional leaders to quickly pass a stimulus plan. "Without a fast and effective response by government," the letter reads, "the economy could continue to spiral downward, leading to a large increase in unemployment and a sharp decline in GDP."

How large a stimulus? Feldstein suggests $300 billion. The more liberal Paul Krugman recommends $600 billion, noting that a contractionary monetary policy could always be used to reel the economy back in, should the stimulus prove inflationary. Goldman Sachs recommends $600 billion. The group of 387 suggests $300 to $400 billion. So there’s some difference of opinion, but also a range—between $300 and $600 billion.

How should it be implemented? Again, minimal controversy. The purpose is not, first and foremost, to add productive capacity to the economy, though that would be nice, but to stimulate demand. That means, as Feldstein notes, "funding spending initiatives that can occur quickly and that would otherwise not be done." Examples would be aid to state and local governments, extending unemployment insurance (as thankfully was done last Friday), and funding of already-planned infrastructure projects.

How urgent is this?

The economy runs on spending—consumer, investment, government, and foreign consumer spending (minus U.S. consumer spending on imports). Homeowners are estimated to have lost about $5 trillion in wealth. If we multiply the $5 trillion by 5.5 cents (a standard estimate of the "wealth effect" whereby $1 of housing wealth leads to 5 or 6 cents of annual consumption), we calculate a fall in consumption of $275 billion. If we take the $10 trillion that USA Today estimates is the loss in wealth from the decline in the stock market and multiply that by 3.5 cents (again a standard estimate of the wealth effect, this time for financial wealth), we get $350 billion. Adding these together, we get a $625 billion drop in consumption expenditure. And now factoring in the credit crisis—which takes perhaps several hundred billion dollars more of credit-based spending out of total spending—and we probably have an overall bite out of GDP of about 6 to 8 percent. These are rough numbers, but even rough numbers, and the fact that every source of private spending (consumer, investment, and export) is heading in the wrong direction, should tell us that we’re facing a calamity.

And the situation is indeed looking worse than several weeks ago. The yield on 3-month treasury bills dipped to zero several times on Friday and ended up at 0.01 percent. When the Treasury can borrow for free, or nearly so, that’s a pretty powerful indicator of a lack of confidence in other financial assets. Goldman Sachs is now estimating a 5 percent annualized decline in GDP for the fourth quarter of this year (revised from a previous estimate of 3.5 percent) and an unemployment rate of 9 percent in the fourth quarter of next year (revised from a previous estimate of 8.5 percent).

What’s clearly needed is some economic agent that can take up some of the slack, that can spend, on credit, much more massively than any other economic actor, and that can carry out such spending intelligently, directing it to where it’s likely to have most effect and then pulling back to avoid negative inflationary or interest rate consequences. As luck would have it, such an agent exists. It is of course the federal government. And it can undertake an utterly mainstream, textbook initiative to avoid avoidable carnage that occurs in an economic downturn. I am referring of course to a fiscal stimulus.

Yet for reasons opaque the Bush administration opposes a fiscal stimulus. Indeed of the three areas in which policy is required Bush has endorsed action in only one, the credit crisis. And there the policy response, the TARP (or Troubled Asset Relief Program), has been plodding at every step and to date inadequate. Could it be, as New York Times columnist Joe Nocera suggested on Bill Moyers’ Journal the other night, that the Bush administration has "thrown in the towel" with respect to solving the economic crisis? If so, this is a serious abdication of responsibility. Lame duck or not, ideologically conservative or not, there’s no excuse for doing nothing while the economy screams.

Thankfully, a very different group of policy makers will soon take over the executive branch. And congressional leaders have pledged to pass a hefty stimulus package for President Obama to sign upon his inauguration on January 20^th. But that’s two months away, and in the meantime it’s as if we’re being dropped without a net while a perfectly good net is available, ready to be used.