Will Obama go for a second stimulus? No …

July 7, 2009

OK, so Laura Tyson thinks a second stimulus might be a good idea. Will the White House go for it The economic logic of such a package might seem compelling. The original $787 billion spending measure was deemed appropriate by the White House for an economy where the unemployment rate was predicted to approach 9 percent in early 2010 if no new fiscal actions were taken.

Of course, the U.S. jobless rate is already at 9.5 percent and President Obama himself predicts a 10 percent rate by year end. Admitting the obvious, Vice President Joe Biden told ABC News that the administration “misread how bad the economy was.”

No shame there, really. Most of Wall Street and the Federal Reserve also underestimated the depth of the recession. But if the disease is worse than first thought, then shouldn’t the treatment be more aggressive?

Maybe not. Anyone want to predict how those killjoy bond vigilantes would react to a second U.S. stimulus plan — say, $500 billion or so in new federal aid to cash-strapped states and cities? Recall that some analysts interpreted the sharp backup in bond yields from mid-March to mid-June as a sign fixed-income investors were getting spooked about the potential inflationary implications of rising U.S. debt.

Now explaining market movements over a short period of time is a tricky proposition at best. But it’s certainly not a stretch to assume that at some point rising debt will cause bond investors to demand higher yields. Indeed, a 2003 Federal Reserve study found that interest rates “rise by about 25 basis points in response to a percentage point increase in the projected deficit-to-GDP ratio, and by about 4 basis points in response to a percentage point increase in the projected debt-to-GDP ratio.”

Don’t bet much that White House economic adviser Larry Summers and budget chief Peter Orszag aren’t aware of that study or the risk that higher yields could suffocate an embryonic economic recovery. No wonder the administration says it is taking a wait-and-see approach as stimulus spending from the existing package “ramps up” this summer and fall.

And the politics of a second stimulus plan are just as dicey for Team Obama as the economics.

Obama was elected to fix the economy. So calling for a “do-over” on his signature economic initiative might call into question the administration’s economic competence. (Republicans are already touting Biden’s admission as proof of that.) Although the administration’s forecast was similar to the prevailing consensus, there were certainly gloomier voices out there, such as Paul Krugman and Nouriel Roubini.

Some might question why the administration didn’t push for an even bigger stimulus package just in case the bears were right. Sure the politics would have been difficult, maybe even impossible. But the White House almost surely could have passed a similarly sized stimulus package that was more front-loaded to boost growth in 2009. (Probably not a bad idea given the adverse relationship between rising unemployment and mortgage defaults.)

What’s more, pushing a second stimulus package would drain energy away from the healthcare and climate change. An administration defeat on one or more of these key issues would certainly leave Democrats weakened heading into the 2010 election. And passing a second stimulus in late 2009 or early 2010 might not provide much of an economic boost before the midterms anyway.

So forget a second stimulus. Boxed in both economically and politically, the administration can do little more than pray those delicate green shoots quickly turn into green stalks.

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