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A Powell Doctrine for the Economy and a Grand Bargain

As President-elect Barack Obama prepares to take office, he faces a nearly unparalleled economic challenge. Instead of inheriting projected budget surpluses as President George W. Bush did in 2001, Obama will inherit a projected deficit for 2009 approaching $1 trillion. On the other hand, Obama is also inheriting an economy that is badly in need of both massive stimulus and major long-term reforms in areas such as health care, climate change and education.

[IMGCAP(1)]Some may call for the new administration to exhibit fiscal discipline by being cautious and careful on fiscal stimulus while lowering ambition on the magnitude and timing of major initiatives on health care, education and climate change.

This would be the wrong approach. Rather than aiming lower, the right answer is a grand bargain on fiscal policy that aims higher by combining a powerful “Powell Doctrine” fiscal stimulus and a bold approach to crucial priorities with a commitment to take on our greatest long-term entitlement challenges.

On stimulus, our economy faces not just a financial and capital market crisis, but also a demand crisis. Getting credit flowing will only do so much good if no one wants to borrow, buy or invest.

When one looks at the state of the U.S. economy — with investment negative and real consumer spending down 0.4 percent over the last year, the first decline since 1991 — it is hard to see where the spark of increased economic demand is likely to come from. Over the past seven years of stagnant or declining incomes, families kept spending largely because of an 800 percent increase in mortgage equity withdrawal — or essentially using their home like an ATM. With home prices down 16 percent in just the past year and almost 20 percent of homeowners now having mortgages bigger than the worth of their home, that source of consumption power has been depleted.

Indeed, at the tens of millions of kitchen tables across the country where families have now felt a dramatic double hit to their home equity and pension savings, there is only one conversation going on: What spending can we cut back on?

If everyone is pulling back at the same time — and as businesses feel or sense this contraction — layoffs follow layoffs making a downward economic spiral only worse. Unemployment, now at 6.5 percent, is projected to rise to more than 8 percent. States — that are now projected to have a $100 billion deficit by 2010 — will add to this contraction with the type of tax increases and spending cuts that are now being considered in California.

And while there was once hope that a weak dollar and strong global demand would drive manufacturing exports, those hopes have been dashed. Estimates of new projected export orders have fallen to their lowest in decades, manufacturing activity is in severe contraction, virtually no growth is projected in Europe and International Monetary Fund projections are barely above rates that define a global recession.

With such bleak prospects, there has rarely been such a strong case for a Powell Doctrine approach to combating the risk of a serious global recession with overwhelming stimulative force. We will need a stimulus of at least $350 billion and possibly well over $500 billion. President Obama should both call for such bold stimulus at home, and then use that call to give him the standing to call for coordinated global stimulus of $2 trillion over the next couple of years.

Such a large stimulus must be temporary and fast-acting, particularly when it comes to state relief, but also must show a strong and steady injection of demand for a longer duration of time than normal — perhaps 18-24 months. And we need to look whenever possible for effective stimulus measures that are win-wins: measures that can both jump-start jobs and jump-start long-term educational, health and energy priorities. And it will likely need to prevent a devastating auto bankruptcy in the middle of our already weak labor market.

Some may argue that such an expensive stimulus should encourage President Obama to pull back on his long-term priorities like universal health care, education or addressing climate change.

A better approach would be a “grand bargain” in which we show long-term fiscal discipline not by doing less on crucial national priorities but by doing more to tackle our long-term entitlement challenge.

One way would be to pass a universal health care plan that through smart and tough measures to bring down national health care costs also lowered the growth of Medicare and Medicaid without turning either program into a second-class health care.

With privatization thankfully off the table, now could be the time to seek a progressive Social Security reform deal that strengthens solvency, ensures Social SecurityÂ’s rock-solid benefit guarantee and increases benefits for widows. It could also include a new universal 401(k) that is separate from Social Security but part of a larger retirement security package that also strengthens defined benefit plans and reduces our nationÂ’s long-term national debt.

It is better to restore our commitment to long-term fiscal responsibility by aiming higher on entitlement reform than to aim lower on badly needed stimulus or long-term solutions to climate change, education and at long last offering affordable health care to all of our people.

Gene Sperling is a senior fellow at the Center for American Progress. He was national economic adviser and director of the National Economic Council from 1996 to 2001.

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