You hear occasionally that the stimulus package is meant to close the GDP gap -- the gap between what we will produce and what we could be producing -- but what that means and how big it is in understandable terms have remained a bit murky. The Wonk Room, though, has a nice post and graph explaining the situation. The GDP gap, they say, "represents workers who want to work but can’t find a job, businesses who are reluctant to hire new employees, land being put to sub-optimal use, and banks and credit institutions who accumulate money instead of lending it out. It’s wages gone unearned, profits unmade and revenues uncollected." This recession, after all, isn't the result of a plague or a drought or a famine. It's the economy's response to an asset bubble bursting. Some of it -- like the decrease in housing prices -- has to happen. But some of it -- like businesses not being able to secure loans because banks are afraid they can't get paid back -- does not. The stimulus is meant to ease some of the avoidable aspects of the recession. Happily -- or unhappily -- economists can actually measure the size of this sort of output gap. And using the measurements of the CBO, the Wonk Room folks created a graph showing that the size of the gap is significant if left unclosed: $8,000 for every man, woman, and child.
That's what the stimulus is trying to avoid. But it won't work if the Obama administration's banking legislation fails. Optimally, the stimulus pumps money into the economy, and the money keeps flowing through. A construction workers gets a job on an infrastructure project, he puts some of the money into the bamk, the bank lends it to a small business, the small business hires another worker, the new worker buys a TV, Best Buy doesn't lay off a salesman, and so forth. But if the banks freeze and feel they need to hoard dollars in order to protect against insolvency, then that stimulus dollar stops at the second step and does fairly little for the economy.
That's what the stimulus is trying to avoid. But it won't work if the Obama administration's banking legislation fails. Optimally, the stimulus pumps money into the economy, and the money keeps flowing through. A construction workers gets a job on an infrastructure project, he puts some of the money into the bamk, the bank lends it to a small business, the small business hires another worker, the new worker buys a TV, Best Buy doesn't lay off a salesman, and so forth. But if the banks freeze and feel they need to hoard dollars in order to protect against insolvency, then that stimulus dollar stops at the second step and does fairly little for the economy. 
