(Image modified, under Creative Commons, from gmutt's original.)

I'm not an economist. But, like you, I'm wondering: will the massive efforts to save the economy work? Here's my sense of what's going on right now.

So far the government's approaches to Great Depression II can be broken down into three main thrusts:

1. Prop up flailing banks by directly shoveling federal tax dollars into the financial institution's coffers (in exchange for a partial equity stake in the bank), or using tax dollars to guarantee or outright purchase 'bad' or troubled' assets from the bank. The official name for the latter program is TARP ('troubled assets relief program'). I prefer BARF, or bad assets relief funding.

2. Catoize it! Encourage indebtedness on the part of individuals and companies by dropping the Federal funds rate (and thus the cost of borrowing money) to as low as it needs to go. Combine this active solicitation of private indebtedness with tax credits and cuts financed by public debt and you have the post-Regan debt-spiral plan of the Republican party.

3. Keynesian full-employment through government spending. This was the ill-fated Stimulus bill was meant to accomplish.

Updated:

David Wright, a sharp commenter and trained economist, pointed out a fourth option:
4. Do nothing.

What I do want to do is add a fourth possibility to your list: we could do nothing. We already have a pretty good idea what would happen under this scenario, too, because this scenario actually played out after the panic of 1873 and in scores of other deep business cycles in scores of other countries in the era before big government. Things would be rough for a few years, and then the economy would recover.

Note that this is exactly what the proponents of the other three interventions claim will happen in their preferred scenarios. So whichever intervention we choose, you can be sure that in a few years its proponents will claim that it was their favored intervention that saved us. I leave it to your scentific mind to judge how much credence you will give to those claims.

In order of least likely to succeed, to most we start with the BARFing out of the banks.

(So much more after the jump!)

This whole notion of gobbling up bad assets, followed by unqualified showering of failed banks with tax money was dreamed up by the braintrust of the Bush admin ('the finest minds of the Ford administration'), based on Sweden's bank bailout in the 1990's.

Here's the underlying idea: if we shove enough money into the banks, some will slosh over as loans to companies and individuals, restoring the cycle of perpetual indebtedness to a nominal state of "unsustainable, but what we know."

Cost? Nobody really knows, because it depends upon the ultimate value of the assets purchased by taxpayers. Hundreds of billions of dollars in losses seem likely, at this point.

Did it work? Nope. In fact, take this comically positively spun article in the New York Times as a guide for how dismally this whole notion has failed:

Bundles of debt are being issued at a pace not seen for months. Some securities on bank books are starting to recover in value. And banks are charging hedge funds and other clients lofty fees for their trades, something they were not able to do when markets were flush and more banks, like Lehman Brothers, were around to compete.

“This is going to shock investors, who think the news is always bad news for these companies,” Richard X. Bove, an analyst with Rochdale Securities, told The Times. “Money’s coming in. Money’s flowing into the financial markets.”

Yay to government funded and sanctioned oligopolies! Huzzah for yet another noose around the neck of investors trying to clear out balance sheets. Victory!

What's next? We've turned small banks into monster zombie banks reliant upon the blood of the people to survive. My retail bank has, in the span of a few months, has gone from Washington Mutual to JP Morgan Chase to finally JP Morgan Chase US Taxpayer.

Why not just kill the zombies and nationalize the failed banks into US Taxpayer-owned institutions? Start with a fresh sheet, let the owners of the failed banks take their hit while protecting the depositors. Eventually, the nationalized banks could be sold bank to a new cohort of private investors. A growing chorus of economists—spanning from Alan Greenspan to Roubini—are convinced this is the best next step. It's what Sweden did, to end their crisis.

The result? Massive drops in the stocks of financial institutions—causing terrifying drops in the DOW and S&P 500. It's a sign that this failed scheme to protect the banks at the expense of the taxpayers is coming to an end. I.e. a good thing for most of us.

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What about the next two approaches, the duel between Cato institute flak and the Keynesian, between the conservative and liberal approaches to the problem? Both of these approaches are addressing the same problem, and even recognize it as the same: there is too little demand relative to the productive capability of the nation's infrastructure and people. The goal is to increase demand, to increase the amount of money spent on American workers and goods.

How is where the approaches diverge. We can see the different approaches in the $787 billion compromise(d) stimulus bill that was just signed into law.

The Republican, Catoization plan, is centered around the notion of shoving cash into the hands of citizens and corporations, in hopes they'll spend the windfall, filling the void in demand created by the collapse. How? On the monetary side, by dropping the Federal funds rate, on the fiscal side, by tax cuts and credits.

$287 billion of the stimulus bill is devoted to tax cuts. For you, it works out to a $400 check for every American worker, plus a slew of little breaks (if you would've qualified for the AMT, have kids, education expenses or are buying a house or car...) Businesses get $10 billion ($3 billion alone is heading to GM).

Monetary policy attempts to shove money into pockets by making borrowing cheaper. One of the first actions in response to this crisis was the dropping of the Federal funds rate (the interest rate banks must pay the government, or indirectly each other, money on the very short-term). The interest rate on everything from mortgages, to car loans, to credit cards is directly or indirectly pegged to this rate. The lower the Federal fund rate goes, the lower your debt's interest rate tends to go. The lower the interest rate, the cheaper indebtedness is. In theory if you make borrowing cheap enough, we'll all gobble up crap on credit, eliminated the gap in demand for goods.

The Federal funds rate has dropped... all the way to zero. Our collective response? We're borrowing less than we've had in years. Exactly opposite of the intent. Good for us. Bad for the economy.

Here's the potential problem with the Cato-Institute approach in a deflationary-spiral situation: The rational interests of the group (spend, you fuckers, spend!) are divergent from the rational interests of a typical individual (save, you might lose your job, save!) If you got a $400 check in the mail today, what would you do?

In come the Keynesians, who believe if the private sector (comprised of terrified individuals and companies) isn't spending, the public sector should. The government should borrow, print money if necessary, and spend until the slack for demand for goods and services in the economy is sated.

Right now, most of us are rationally frightened, frugally saving in anticipation of a lost job and a long period of unemployment. If you see that the government is hiring just about everyone who asks, you should relax a bit. Lose you job now, and governmental job you get might suck—but you'll at least be fed, warm, clothed and indoors. Such full-employment programs make the intelligent self-interests of the individual match those of the whole: Spend appropriately for your needs. So goes the theory.

And, it worked in the past. While some argue about what really ended the Great Depression, most economists agree that the combination of the massive works projects in the New Deal, plus the "employment" of the rest of the population in the efforts for World War II ended the last stint in total economic failure. By the early 1940's, if you wanted work you could find it. It might be as a soldier, but work was there.

Looking at the remainder of the $787 billion stimulus bill, much of it is this sort of Keynes-approved public spending. $44 billion to upgrade the nation's energy infrastructure, $48 billion for transportation, $29 billion for scientific research and such are all likely to result in paychecks into people's pockets—solid jobs with a clearly distant expiration date.

It really doesn't matter what these jobs are, from the perspective of restarting the economy at least. It would be ideal if these jobs, if this public spending, were going to things we desperately need and want. If enough public money went to pairs of people—one digging holes, the other filling them—it would do the job. Just very inefficiently.

From a Keynesian point-of-view, the problem with the stimulus bill is it isn't big enough. Too little of the money goes to job creation, too much to bullshit like tax cuts and ill-conceived incentive programs meant to induce corporate investment.

A proper investment by America in the public sector is probably long overdue. There are a lot of very smart and capable people unemployed right now. As new governmental employees, they could form a profoundly smart and capable civil service—an army of regulators, scientists and administrators to start tackling the massive environmental, financial and education problems we face.

The Keynesian approach is criticized from the Right for concentrating too much economic power into the hands of the government. For those determined to make government small enough to drown in a bathtub, this is an anathema.

Another rational concern of such a plan, particularly if the government cannot borrow and must start printing money to fund these programs, is of hyper-inflation—or a massive, out of control drop in the value of a dollar. The risks of such Wiemar-German style inflation (or present day Zimbabwe-style) massive inflation seem low. For now, at least, the US government is borrowing with ease. Just about anyone with saving is shoveling their money to the government. All we want is to get our initial investment back. A return on investment is pretty damn luxurious, in the present conditions. The US government should be borrowing (from it's own citizens as well as investors from overseas) reasonably well for the near-term. Maybe.

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So, there you have it. My best understanding of the three big approaches to righting the economy.