In a speech last month, Federal Reserve Vice Chair Janet Yellen identified some causes of the “painfully slow recovery for America’s workers.” Some of the causes she mentioned can’t be easily remedied; they’re at the core of the problem itself. In particular, residential investment has historically served as the leading edge of recovery. In this recession, which was largely triggered by the enormous bubble and bust in the housing sector, it’s not surprising that residential investment isn’t leading the way out.
But other causes of the slow recovery are deliberate and self-inflicted. Yellen highlighted the drag created by austerity. The figure below (Yellen’s Exhibit 3) compares what “discretionary fiscal policy” did for the economy in two recent recessions with its role in the Great Recession. The azure, blue, and lavender bars show the impact of discretionary fiscal policy on GDP growth one, two, and three years into each recovery.
Estimated effect of discretionary fiscal policy on the economy during recoveries: average contribution to GDP grown, percentage points (annual rate)
Note: Average recovery from postwar recessions excludes recovery after 2007-09 recession because of data limitations; average also excludes recovery after 1948-49 recession. Source: Federal Reserve Board staff calculations.
We got off to a reasonable start with the Obama stimulus. The contribution to growth was not quite as vigorous as Ronald Reagan’s military-Keynesian and tax-slashing buildup in the early 1980s or even George W. Bush’s early 2000s reprise thereof (second-time farce). Right off the bat Reagan’s deficit spending was adding almost one percentage point to GDP growth and did so for three years, and the Bush results were pretty similar. After one year Obama’s stimulus was actually more responsive to the recession than the average government response in post-WWII recessions (and it was done with less military expansion and fewer tax cuts for the very rich than were the Reagan and Bush stimuli).
But then the brief Keynesian moment passed. First states, cities, and towns slashed jobs and services to meet balanced-budget obligations. Instead of buying groceries, clothes, and new green cars, laid-off teachers and state workers joined the unemployment rolls. And then the austerity bug caught in Washington. In years two and three of the recovery and since, our government’s deficit obsession has been actively dragging down the economy, a headwind, in Yellen’s terms, of -0.2 percentage points compared to a Reagan-era tailwind of 1 percentage point per year. The worst part is that is that the damage is self-inflicted and could well have been avoided.
