Tag Archives: Laura Tyson

The only way out is through (updated)

Posted on by at 7:34 am

Unemployment in the US is now at 9.2%.  If you include people who want to work, but are working only part time or have given up looking for now, the rate is 16.2%, or about 1 in 6 of all American adults.

Given these grim numbers, three years after the largest collapse of a financial bubble since the Great Depression, there should be calls for a sensible economic response. Such a response would include short-term tax reductions and Federal spending increases, married to long-term debt reduction.  In times of economic collapse, while citizens and business need to retrench and rebuild their balance sheets, the Federal government should increase outlays over the short- and medum-term in order to offset, to the extent possible, the collapse of demand and spending in the private economy.  Deficit reduction could be triggered when unemployment reaches a reasonable (but not perfect level), say, 7.5%.

The stimulus bill early in 2009 was enacted for this purpose and, while the GOP clamors that it “failed,” the fact is that it did preserve and create some jobs, and the current economy is better that would be without that action. If there was a failure, it was that the stimulus was too small.

Paul Krugman in January, 2009:

Even the C.B.O. says, however, that “economic output over the next two years will average 6.8 percent below its potential.” This translates into $2.1 trillion of lost production. “Our economy could fall $1 trillion short of its full capacity,” declared Mr. Obama on Thursday. Well, he was actually understating things.

To close a gap of more than $2 trillion — possibly a lot more, if the budget office projections turn out to be too optimistic — Mr. Obama offers a $775 billion plan. And that’s not enough.

Now, fiscal stimulus can sometimes have a “multiplier” effect: In addition to the direct effects of, say, investment in infrastructure on demand, there can be a further indirect effect as higher incomes lead to higher consumer spending. Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50.

But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts — and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. (A number of Senate Democrats apparently share these doubts.) Howard Gleckman of the nonpartisan Tax Policy Center summed it up in the title of a recent blog posting: “lots of buck, not much bang.”

The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.

The approach outlined above is Economics 101 and the basic teaching of John Maynard Keynes. [As a side note, it is unfortunate that the overwhelming expenditure of Federal dollars at the time of the collapse went Wall Street and other financial entities who themselves were the fundamental source of the bubble, rather than to truly stimulative spending.]

But instead of calling for increased Federal spending over the short term, the GOP is demanding immediate, substantial cuts in Federal expenditures. And the President is calling for tax increases, along with expenditure cuts. Taken together both the GOP and President are advocating a powerful austerity program, the worst policy approach to address a shortfall in aggregate demand, leading to underperformance of the economy.  Both approaches powerfully reduce demand.

There is one reasonable way out of the morass. Laura Tyson:

There is a logical way out of this policy conundrum: pair temporary fiscal measures targeted at job creation during the next few years with a multiyear, multitrillion-dollar deficit reduction plan that would begin to take effect once the economy is closer to full employment. Pass both now as a package. Current signals from Washington indicate that this way out will be not taken: instead, partisanship and politics will trump logic and premature fiscal contraction will undermine the already anaemic recovery. Even worse, a political stalemate over the debt limit could precipitate a financial crisis…

More from Krugman:

Updated: And lest you believe that fiscal stimulus will cause a spike in inflation and interest rates, take a look at this chart from the Federal Reserve Bank of St. Louis:

As you can see despite the large deficits from 2007 on, and constant harangues from inflation hawks about the purported danger of such deficits, while unemployment remains high, there is no sign whatsoever of surging interest rates (reflecting a lack of inflation). Of course, this should not be surprising given the huge underutilization of our productive resources reflected in the unemployment numbers.  Inflation is cause by too many dollars chasing too few assets. Our country is currently brimming with unused and underutilized assets.  The low interest rates shown also reflect a continuing willingness on the part of international investors and sovereign funds to purchase our Treasury obligations.  Simply stated, despite the deficits and Federal debt, the rest of the world continues to view the US as a safe haven.  (via Paul Krugman)

And there is this from David Leonhardt:

Financial crises have long hangovers, and this one is no exception. Home sales and car sales remain depressed, nowhere near their earlier peaks, even though the population has continued growing. Europe still has the potential to upset global financial markets. If Congress doesn’t act on the debt ceiling soon, so does the United States.

In all kinds of ways — consumer demand, the federal deficit, even the weather — the medium-term future is highly uncertain. But this uncertainty, while the main problem, is not the only problem. We are also committing an unforced economic error. We’re cutting government at the same time that the private sector is cutting.

It is the classic mistake to make after a financial crisis. Hoover and even Roosevelt made a version of it in the 1930s. The Japanese made a version of it in the 1990s. Now we are making it.

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