When you do well in grad school economics, you adhere to first principles, dig deep into well behaved data, and come up with some new result, but only one which reinforces current theory, particularly that of your adviser.

When you attempt public policy, you rarely find out until too long after that what you thought would work didn't work so well.  Most professors and most policymakers prefer not to acknowledge that.

When I started out in 1974 as a 23-year old economist on the Joint Committee on Taxation, we really believed we could micromanage the economy with fiscal policy.  Future Nobel Prize winner Lawrence Klein had just developed the first large scale macro model of the U.S. economy.  It showed with seeming precision exactly how much GDP growth we could get from a tax cut or government spending increase.  During the 1975 recession, I formulated the first individual income tax rebate.  We were convinced that this would quickly revive the economy.  It certainly seemed to do so at the time.  It was only later that we learned that the bulk of the rebate had been saved, and that the economy had rebounded for other reasons.  Research on the 2001 tax rebate showed that only between 20% and 40% of it was spent on non-durable goods in the first three months after it was received.

Monetary policy came into vogue in the 1980's.  Milton Friedman led a revolution among economists away from fiscal policy and toward more careful control of monetary policy to dampen cyclical swings.  The only problem was we couldn't seem to find a measure of the money supply that held up to econometric scrutiny.  Our results were only as good as the lag structure in those equations, and it eventually became apparent that the false precision of monetary policy theory was no better than the false precision of fiscal policy theory.

Our current recession has provided proof that another rebate of 1¼% of GDP just postponed the recession for a quarter or two and monetary policy has been equally ineffective.  What do you do when the policy levers don't work?

Congress and President-elect Obama are poised to adopt a much larger fiscal stimulus bill, on the order of $500 b.  Perhaps 1¼% of GDP is not enough.  Let's try 3½%.  This is like getting stuck in the ditch, spinning your tires, and deciding to spin them even faster to get out.  It doesn't work.  You need more traction.

The next step will be to spend more money on infrastructure investment, roads, bridges, and other large scale public works.  They definitely create jobs, but they take years, not months, to stimulate the economy.  They only benefit the economy if they prove more productive than the alternative uses to which that tax money could have been put.  A bridge to nowhere is still a bridge to nowhere.

We economists haven't experienced a nationwide "liquidity trap" since the early 1930's.  We're in one now.  The Fed had cut interest rates to 1% and has pumped hundreds of billions of dollars into the economy, but this has just been "pushing on the string."  Almost all of that increased liquidity has been saved by consumers and by banks.  No one is lending, and no one is buying.

How do we get traction?  Policy traction will return only when banks regain faith that their loans will be repaid and when consumers believe their income is secure enough to spend on credit again.  We'll have to wait until we can pay off enough debt.  We'll have to wait until we have more faith in our political leaders.  We'll have to wait until we're less fearful of a medical emergency with no health insurance.  We'll have to wait until we feel more secure.  One thing about Americans, they dislike waiting for anything more than just about anyone on the planet.  Impatience won't help us.  Calm, steady, and forceful policy actions will help, but it will take time.  We didn't jump into this economic mess overnight; it will take us a while to get out, hopefully by the end of next year.