Felix Salmon writes

In this kind of a recession, monetary policy — reducing rates to zero — doesn’t work. And tax cuts don’t work either: they just increase household savings. You need government spending, at least until the economy has warmed up to the point at which companies and individuals start borrowing again. And the good news is that in a balance sheet recession, government spending is pretty much cost-free, since interest rates are at zero.

Except that rapid increases in household savings will cure the balance sheet recession. With all due respect to Felix I think this is part of the ideological blinders than lead to bad policy on all sides.

One can make an easy case that direct government spending would generate more immediate stimulus in general and especially during a balance sheet recession.

However, folks are weary of direct government spending. Rather than wasting a lot of time and energy arguing over that its better to simply choose policies that everyone can agree on and then go really huge on those polices.

My original suggestion from early 2008 was a complete suspension of the payroll tax combined with open ended loans to State and Local Governments. I still think that would have given us a much quicker repair than we saw.

Note we would be transferring at least $450 Billion a year into households pockets and potentially savings. Though likely the net effects would have been much larger as no payroll tax would have increased labor demand.

As it was households only reduced their total debt by about $700B over the course of the last few years. Meaning that they could either have accomplished this entire adjustment by sometime in 2009 or if they had continued to save the entire portion then by now they could have made an adjustment at least two and half times larger.

FRED Graph

Further, even if you don’t buy the idea that the marginal effect of taxation would have mattered much in the recession the relaxation of cash flow constraints on businesses would have. That is, some businesses slowed down radically on hiring in part because they were unsure if they would be able to meet payroll. Lowering the cost of payroll would have lowered that.

However, we can take it even further. One of the goals of the Administration and Democratic Congress was clearly an expansion in health care.

Suppose at the apex of the crisis you have offered to Federalize Medicaid. That is to move the entire program to being funded by the Federal government. The logic being that this would remove a huge burden from the states at a time of crisis and give the states vastly increased flexibility.

In both cases what you are doing is moving liabilities off of state and private balance sheets and on to public balance sheets. This is exactly what you would want to do in a balance sheet recession and it could be done without authorizing any new spending.

Again my point here is not argue whether this would have been the best conceivable policy but whether or not it would have been a better policy than we got and less hamstrung by partisan differences.