OK, what happens when a company or organization decides to invest in a new building, factory, or whatever else? They hire people to do the work and place orders for the necessary materials. This creates employment, the employed workers spend money, other businesses hire people to meet those workers' demand, and the economy is "stimulated," as it were. Most of the time, this process continues on its own quite nicely.
However, back in the first quarter of 2007, banks and other financial institutions began realizing that the boom of 2002-2007 was a sham, and that a lot of loans they made during this period would never be paid back. This forced them (i.e., Northern Rock) to write down the value of these loans on their balance sheets - meaning they had to absorb lots of financial capital in order to remain solvent. Of course, as this boom was induced by the Fed and the government (through tax cuts and guns-and-butter spending), there were a lot of insolvent financial institutions - in truth, the entire global financial system is insolvent.
Now, since the banks in trouble stopped making loans and started absorbing capital from the system, there was less money in the system as a whole. With less money in the system, more and more banks found that they needed to cut back on loans and get their balance sheets in order. The first organizations to come under pressure were the most heavily leveraged - Bear Sterns, followed by Lehman Brothers. While Bear was bought out, Lehman was allowed to fail. This failure produced a systemic failure known as "cross-cascading default" - Lehman defaulted on their obligations, which caused all of the companies that held them (i.e., AIG) became insolvent - a domino effect, in other words.
Long story short, Lehman's failure caused an electronic run on money market mutual funds in the US and around the world on September 16th. All of the "sell" orders forced money market yields through the roof, causing several of such funds to "break the buck" - the value of the assets in the fund dropped below $1 for every $1 in equity. This is important, because the money market is the market from which companies borrow liquidity at short term - without it, the economy stops. At this point, the Treasury had no choice but to shut the money markets down and guarantee the deposits - if they hadn't, the entire world economy would have collapsed by the start of the next business day. Britain in particular came within 2 hours of a total collapse. Sans technical stuff, all of this is equivalent to a run on every bank in the world at exactly the same time.
That stuff is important because, though the money market was shut down before the banks had run out of reserves, it did cause lending to grind to a halt. Without access to borrowed short-term liquidity, companies began laying off workers en masse so as to preserve the cash they do have. This created a vicious cycle in the real economy - as more companies laid people off, others had less revenue, leading them to lay people off as well. Predictably, this caused many more defaults on consumer debt, with the accompanying financial effects.
So that leaves us at our present predicament - without some entity to step in and provide income to get the system going again, it will continue collapsing. The government is the only extra-market actor capable of doing so, which is where the stimulus comes in.
What the stimulus does is to authorize expenditures for various investment projects in the public sector - remember back to the first paragraph, and how investment creates jobs. So that's the short-run "stimulus." Notably, it also provides not only immediate demand for goods and services, but delivers a long-term return on investment as well.
Also, the collapse in demand is so bad right now that the only way to stimulate is for the government to actually go out and spend the money itself. We already know tax cuts won't work because monetary policy actions haven't worked - short-term interest rates are at zero, yet despite the flood of money, it's being hoarded (primarily by the banks) and taken out of circulation faster than the Fed can print it. This itself largely owes to monetary and financial mechanics - specifically, the large disparity in wealth distribution which has arisen since the Reagan years, and has become especially acute since 2001. That's not really the point though - the point is that the economic effects of tax cuts and monetary easing are exactly the same. In short, there's no reason to put even a dime of tax cuts in the thing, because people will just use them to pay down debt. I'd also point out that those advocating ONLY for tax cuts really have no clue about what they're talking about.
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Oh yeah, and as to what's "enough" for the stimulus - hard to say with certainty, and it depends on the nature of the spending itself, but I'd say nothing less than $2 trillion in actual spending (tax cuts don't count) will allow us to avoid a severe depression.
Answered By: The Daily Elitist - 2/10/2009