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.
Now that the deadline has passed on Friday for preventing $55 billion in annual cuts to both social and military spending relative to previously allocated levels, it is unambiguous that federal fiscal policy is dominated by an obsession with lowering the government’s fiscal deficit and debt. This is despite the fact that, as I have discussed repeatedly in blog posts, in Back to Full Employment and elsewhere, and as many, many other sensible people, including many co-bloggers on this site have also argued, that this is exactly the opposite of what we need to do to move the U.S. economy onto a decent growth trajectory. That is, this is the opposite of what we need to start expanding new job opportunities and moving the economy onto a path toward full employment.
Yes, President Obama and Congress could possibly come up with some new agreement in the coming weeks or months. But based on where the discussions have been for the past 18 months, and where the reports say they may be heading in the coming months, it is almost certain that any new agreement is not going to be more than marginally better than where we are now. The fundamental problem is that President Obama and the Congress are talking about the wrong thing. They believe, or have been led to believe by deficit-hawk economists such as Professor John Taylor at Stanford , that the overriding problem in the economy today is the fiscal deficit. In fact, the overriding problem is mass unemployment. As long as our leading politicians continue to address the wrong problem to begin with, they will never get anywhere near tackling the right problem with viable policies.
This was a big part of the theme of a blog that I posted last December 29, “As Congress Fiddles, the Fed Can Still Take Real Action on Jobs,” and of other posts as well. In the December 29 post, anticipating that Congress and the President would continue going nowhere or backwards as they have been, I argued that the Federal Reserve still has tools at their disposal for bringing unemployment down. The key here is for the Fed to force the commercial banks to disgorge themselves of a good share of the $1.6 trillion—i.e. 10 percent of U.S. GDP—they are still holding in massive cash hoards and to put that money in the hands of small businesses as affordable credit. This is money the banks have gotten for free through the Federal Reserve’s near-zero interest rate policy for banks. This would enable small businesses to start hiring people and grow again. In addition, the Federal government should extend loan guarantees for small business loans specifically to further encourage this credit expansion to the greatest possible extent and as quickly as possible.
I don’t mean to claim that this is the best possible policy option. Of course, it would be better if such measures were accompanied by the federal government expanding its spending on education, health care, family support, infrastructure and the green economy. But such an increase in government spending is obviously not happening now. So that raises the question, just how much could the Fed do with the policy tools I am proposing?
This exact question was posed to me recently by Professor Thomas Weisskopf of the University of Michigan. A little background: As I hope many readers of this blog know, Tom has long been among the most insightful and accomplished progressive economists in the world. In recognition of Tom’s contributions, Jeannette Wicks-Lim and I organized a conference in his honor in September 2011. A book of the conference papers, titled Capitalism on Trial, will be appearing next month from Edward Elgar Publishers (the papers have been presented on the PERI website in serial form for the past few months). In what follows, Tom asks me a series of highly pertinent questions on my proposals for fighting austerity through the Fed. I hope my answers that follow his questions will be persuasive to Tom and everyone else. In any case, here we go:
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This Friday, March 1, federal budget sequestration is set to take effect unless Congress intervenes to prevent it. At stake is about $85 billion, split between military and non-military federal budgets. In the past days and weeks we’ve seen a variety of articles about the impacts of these cuts, and earlier this week the White House released its estimates of the potential state-by-state impacts of the sequester.
Here I want to focus in particular on a few points that I feel are underrepresented in discussions of budget sequestration, most notably by those trying to protect defense spending from budget reductions. A recent article in The Hill focused on the impacts to the defense industry mentions a few of these points that are worth highlighting. More / Comments
Amid the wreckage of the 2008-09 Wall Street collapse and Great Recession, orthodox economists and political elites in both the United States and Western Europe have been strongly and consistently pushing the idea that the only way out of the mess is to deliberately make life worse for almost everybody. Details aside, this is the basic idea behind the austerity agenda that has become the conventional wisdom in both the U.S. and Europe, regardless of which political parties happen to hold office. It is the underlying premise for both the Democratic and Republican sides of the current debate over sequestration—i.e., imposing across-the-board cuts on social spending and defense, starting this coming Friday.
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This strange animal called sequestration is certainly wreaking havoc with our customary ideological boundaries.
If you’re an advocate, like I am, for revamped federal priorities that shift resources from a bloated Pentagon budget toward neglected domestic priorities, your take on this animal can’t be simple. You say cutting everything indiscriminately is a bad way to run a government (this view is nearly universal). You oppose the cuts in the domestic budget that will leave us with fewer food safety inspectors, medical researchers, Head Start teachers, and airport baggage screeners on the job. But you can reel off long lists of ways to cut waste in the Pentagon budget to the levels prescribed by sequestration, and show that these cuts will leave us completely safe.
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