Tag Archives: budget

The Fiscal Stimulus & Market Turnaround: 5-Year Anniversary

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Commentators are taking note of the five-year anniversary of the fiscal stimulus that President Obama enacted during his first month in office.   Those who don’t like Obama are still asking “if the  fiscal stimulus was so great, why didn’t it work?”    What is the appropriate response?

Those who think that the spending increases and tax cuts were the right thing to do have given a number of responses, which sound a bit weak to me.  The first is that the stimulus wasn’t big enough.  The second was that the Great Recession would have been much worse in the absence of the stimulus, perhaps a replay of the Great Depression of the 1930s.  (The media are fond of this line of reasoning because it allows them to escape making a judgment.  They can just say “nobody knows what would have happened otherwise.”)    The third response is that the fiscal stimulus was short-lived, and in fact was reversed by the Congress by 2010.

I believe that each of these three statements is true.   But they sound weak because they look like attempts to explain away the absence of a visible positive impact.  Listening to these arguments,  one would think that no effect of the Obama stimulus could be seen by the naked eye in the U.S. economic statistics of 2009.    Nothing could be further from the truth.

Recall the timing.  Obama was sworn in on January 20, 2009. The economy and financial markets had been in freefall ever since the Lehman Brothers failure four months earlier (September 15).   The President quickly proposed the American Recovery and Reinvestment Act, got it through Congress despite strong Republican opposition, and signed it into law on February 17.   

If one judges by the economic statistics, the effect could not have been much more immediate, whether the crierion is job loss, GDP, or financial market indicators.   Look at the graphs below.  

The stock market, which had been falling steeply since September, hit bottom on March 9, 2009, and then started a 5-year upward trend.   The index shown in Figure 1 is the S&P 500.  The turnaround can’t be missed.  Wall Street should get ready to celebrate the anniversary on March 9.

Figure 1








Figure 1: Stock Market   
*Click on the chart for larger image

The much-maligned TARP and bank stress-tests also played important roles, unfreezing financial markets.  Bank interest rate spreads were back to pre-Lehman levels by February 2009 and back to pre-subprime-crisis levels by June.

What about the real economy?  That is what matters, after all.   Economic  output was in veritable freefall in the last quarter of 2008: a shattering 8.3 % p.a. rate of decline (BEA).  More specifically, the maximum rate of contraction came in December 2008, according to the monthly GDP estimates from the highly respected MacroAdvisers.   (For charts in the form of growth rates, see Figures 1 and 2 of my post on the 3-year anniversary.)  The free-fall stopped in the first quarter of 2009.   As the GDP graph below shows, economic activity was flat, scraping along the bottom until June, after which growth resumed.   The official end  of the recession thus came in June.   Visible to the naked eye.









Figure 2: Level of GDP, monthly(Dec.2006-Dec.2013)
estimated by Macroeconomic Advisers
*Click on the chart for larger image

The rate of job loss bottomed out in March 2009.  It is there for anyone to see.   The graph shows private sector employment changes.  Thus the turnaround does not count government jobs directly created by the fiscal stimulus.  Job creation turned positive after the end of the year.  Since then, though employment gains have been much too slow, they have on average exceeded the rate during the corresponding period under George W. Bush.

 Figure 2

Figure 3: Change in Private Sector Employment
*Click on the chart for larger image

Of course there are always a lot of things going on. One cannot say for sure what was the effect of the Obama stimulus. And one can debate why the pace of the expansion slowed after 2010. (My own prime culprit is the switch to fiscal austerity.)

But whether looking at indicators of economic activity, the labor market, or the financial markets, the idea that the fiscal stimulus of February 2009 had no apparent impact in the numbers is wrong.

[Comments can be posted at the Econbrowser version or in the always-lively debate at Economist’s View.]

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Will Financial Markets Crash Before October 17, or After?

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October 4 is the first Friday of the month, the day when the Bureau of Labor Statistics routinely reports the jobs numbers for the preceding month.   Is the havoc created by our current political deadlock over fiscal policy showing up as job losses?   We have no way of knowing.  On October 1 the BLS closed for business, like many other “non-essential” parts of the government.  There will be no more employment numbers until the shutdown ends.

Last week, Wall Street economic analysts responded to the usual surveys as to what they thought the upcoming employment numbers would be.   (These surveys are what the media refers to each month when they tell you that employment rose or fell “more than economists expected.”)    The median forecast in last week’s  Bloomberg survey, for example, was a prediction that the BLS would report that “Payrolls increased by 175,000,” the biggest gain in four months.   But there was no word on how many of the respondents recognized that there would in fact probably be no number at all on October 4, because the Labor Department would have been closed by the government shutdown.

It seems to me that this minor blind-spot is symbolic of a failure of Wall Street to focus adequately, until now, on the long-impending government shutdown and still-impending October 17 deadline for raising the national debt ceiling.   One reason for the lack of concern up until this point is that observers are jaded; they feel they have seen this movie before (with fiscal cliffs, sequesters, shutdowns, and ceilings); that it is “only politics;” and that Washington always averts catastrophe at the last minute. Well, maybe not this time. 

Another reason is that the financial markets all summer long were busy over-reacting to developments regarding the Federal Reserve.   The stock market reached a high two weeks ago on the information, which was considered news, that monetary policy was not going to be tightened imminently after all.   Now the fixation is passing from monetary policy to fiscal policy. Not a moment too soon.

Both sides in Washington are firmly dug in, and don’t plan to back down.  If the politicians don’t get their act together  and the debt ceiling is really not raised, the results will be very bad indeed.   I actually mean “if the Republicans don’t get their act together.”  I think President Obama is fully credible when he says he will not let one faction in one party in one house of congress, in one branch of the government, threaten to blow us all  up if they don’t get their way on the Affordable Care Act.

The US has never defaulted on its obligations before.  Some continue to imagine that the government could stay within the debt ceiling but meet its obligations out of incoming tax revenue.  This is wrong.  Even if there were enough tax revenue to service the treasury debt for awhile, there would not be anywhere near enough to meet all the other legal obligations that the federal government has already incurred under the congressionally passed budget.  If the government doesn’t pay Staples the money that is owed for office supplies that it bought last month, that is a legal default just as much as if it fails to service its bonds.  

Perhaps, given the desperation of the situation when the time comes, President Obama could try one of the gimmicks that have been proposed, such as minting the trillion dollar coin or taking the position that the debt ceiling violates the constitution or other laws.   These are not attractive options because they would probably provoke a constitutional crisis.   So let’s assume that he doesn’t take them.

It seems to me that this then leaves two possible outcomes: either the financial markets fall before October 17 and the Republicans respond by backing down or the financial markets fall after October 17 and the Republicans respond by backing down.   Precedents for financial markets forcing such a reversal include the delayed congressional passage of the unpopular TARP legislation in the fall of 2008 and the delayed passage of an unpopular IMF quota increase 10 years earlier.   (In the last debt ceiling showdown, in August 2011, default was avoided at the last minute;  but the stock market fell sharply anyway, when S&P for the first time ever downgraded US debt from AAA.)

After a remark by Obama about the markets yesterday, some accused him of “scare tactics,” of fanning Wall Street fears for political advantage.  The reality is almost the reverse:  if Obama thinks like a pure politician, he will let the Republican Party complete the process of committing suicide (suicide by means of binge tea partying).  The way to do this would be to wait until October 17 and let the Republicans take the blame not just for a decline in the stock market or for the inconvenience to anyone who has to deal with the government during the shutdown, but – if there is no resolution in time to raise the debt ceiling – to take the blame for the likely result: a second global financial crisis and global recession.   

But that would be a very high price to pay for political advantage.  Even if the Republicans cave in within a few days after October 17, so as to avert the global recession, by then the creditworthiness of US Treasury debt will have been irreparably harmed.  My guess is that Obama thinks it would be much better for the country if the markets were to tank and the Republicans to back down before October 17 rather than after, even though the Tea Party would then live to fight another day.

[I discussed these matters this morning on BBC radio, “US Shutdown Risk to Global Economy,” and Fox Business News, “Who Will Listen to the President’s Warning to Wall Street?” Varney & Co..  One of the Fox team claimed that the stock market has usually gone up in government shutdowns.  It turned out that her statistic referred to the subsequent month;  in other words the market goes up when the shutdown is ended.  In fact it typically goes down during shutdowns, by 2 ½ % in the case of those lasting 10 days or more. It looks to me that this exchange was excluded from the segment posted on the Fox website.] 

Comments can be posted at the site of the Project Syndicate blog version of this post.

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Does Debt Matter?

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“Does Debt Matter?” is the question posed by The International Economy to 20 commentators:
“The recent scrutiny of the popularized version of the Rogoff-Reinhart thesis (that growth plummets when debt exceeds 90 percent of GDP) makes clear there are no simple formulas for determining the risks in the level of a nation’s debt. …Can a realistic guide be fashioned for determining whether a nation’s debt has reached a danger zone? Or are countries from here on expected to pursue fiscal reforms only if and when a crisis sets in?”

My response:
          Yes, debt matters.   I don’t think I know of anyone who believes that a high level of debt is without adverse consequences for a country.  There is no magic threshold in the ratio of debt to GDP, 90% or otherwise, above which the economy falls off a cliff.    But if the debt/GDP ratio is high, and especially if the country’s interest rate is also high relative to its expected future growth rate, then the economy is at risk.  One risk is that if interest rates rise or growth falls, the economy will slip onto an explosive debt path, where the debt/GDP ratio rises without limit.  In the event of such a debt trap, the government may have no choice but to undertake a painful fiscal contraction, even though that will worsen the recession.  (The resulting fall in output can even cause a further jump in the debt/output ratio, as it has in the periphery members of the eurozone over the last few years.)  
          None of that means that austerity in the midst of a recession is a good idea.  Reinhart and Rogoff never said it was, either in their research or in their policy advice. Rather, as Keynes said, the time for fiscal austerity  is during the boom, not during the recession.  Indeed, a good reason to reduce the debt/GDP ratio during a boom is precisely to create the space for budget deficits during downturns.
          No; countries should not be told “to pursue fiscal reforms only if and when a crisis sets in.”   Rather, high-debt countries should take advantage of periods of growth to eliminate budget deficits before a crisis sets in, so that they do not find themselves in a debt trap.  The time to fix the hole in the roof is when the sun is shining.   Most European countries failed to take advantage of the growth years 2002-2007, to strengthen their budgets, and are now paying the price.    The Greeks spectacularly failed to do so, with the result that they have had to go up on the roof to attempt to fix the hole during a thunderstorm, a task that is unpleasant, difficult, dangerous – and probably impossible.  
          If you want to identify some research that has misled politicians, go for the papers suggesting that  fiscal contraction is not contractionary and that it may even be expansionary.   It is true that sometimes a country may have no alternative to fiscal contraction;  but that does not mean it is expansionary, especially if the currency cannot be devalued to stimulate exports.
          The United States also failed to take advantage of the growth years 2002-07 to run budget surpluses.   But fortunately our situation is completely different from Greece’s:  our creditors are happy to hold dollar bonds, even at rock-bottom interest rates.  They are not imposing on us short-term recession-inducing fiscal austerity.   We should not impose it on ourselves while the economy is still weak.   Instead, we should take steps now that will restore fiscal discipline in the future. 


          [Comments on this blog can be posted at the Project Syndicate site.    For all 20 responses to the question, “Does Debt Matter?,” see the symposium in the spring 2013 issue of The International Economy.]
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