$600 Billion - Gulp

One of the great things about an Obama administration is that Paul Krugman can get back to writing interesting economics pieces for the popular press rather than his anti-Bush writings. Today's NYT piece is a good example of just such a piece. Using Okun's law, he estimates that we need a fiscal package of $600 billion to close the output gap. Wow.

My issue with this is that, while I agree that we're in depression economics mode, I don't understand how fiscal stimulus actually helps us. Fiscal stimulus deals with aggregate demand shocks (ie, reductions in aimed spending by consumers, firms, government and the foreign sector), and it's clear that there's been an aggregate demand shock. These falling housing prices have caused capital losses for consumers, as had the stock market crash. But the real boogeyman is the effect that falling prices had on bank solvency. It's the insolvency in lendors that has created difficulty in getting credit, and in turn started to effect the real economy and thus firm investment. And that, in turn, has fueled even more drops in spending by consumers, and in turn drops in spending by government due to falling tax revenue, and contagion effects throughout the world as trade slows down, and therefore so does exports. Giving Americans money doesn't ultimately address that insolvency, does it? Why not spend the $600 billion and go directly to the heart of the problem - either by recapitalizing banks (second best), or buying up excess inventory of houses. Even better would be to let someone else by those houses - let foreigners buy them, for instance, in exchange for US citizenship. Anything that can buoy the housing prices seems like it deals with the insolvency problems. But the drop in consumer spending? That's a consequence of insolvency, not a cause itself, so how does stimulating it not simply postpone the problem?