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.
Politico asked 8 of us for a prognosis on US growth in the new year. This was my response –
Something important will get better in 2014: Fiscal policy will stop hurting the economy. The results should show up as expansion in such service sectors as health, education and construction.
The biggest impediment to economic expansion over the last three years has been destructive budget policy coming out of the Congress: misguided fiscal drag in the short term (crude cuts in spending, especially under the sequester; the expiration a year ago of Obama’s payroll tax holiday); repeated unnecessary disruptive and uncertainty-maximizing political crises (debt ceilingshowdowns and government shutdown); and little progress on the genuine longer-term fiscal problem, which is the 40-year prognosis for U.S. debt (a result of projected rapid growth in entitlement spending). These fiscal failures have together probably subtracted well over a percentage point from U.S. growth in each of the last three years.
Several of my colleagues on the Harvard faculty have recently been casualties in the cross-fire between fiscal austerians and stimulators. Economists Carmen Reinhart and Ken Rogoff have received an unbelievable amount of press attention, ever since they were discovered by three researchers at the University of Massachusetts to have made a spreadsheet error in the first of two papers that examined the statistical relationship between debt and growth. They quickly conceded their mistake.
Then historian Niall Ferguson, also of Harvard, received much flack when — asked to comment on Keynes’ famous phrase “In the long run we are all dead” — he “suggested that Keynes was perhaps indifferent to the long run because he had no children, and that he had no children because he was gay.”
After a month of high drama the Senate at high noon today voted to pass a bill to raise the debt ceiling. How to evaluate this outcome? If I must give a one-word verdict, it would be “good.” If I can expand to two words, it would be “not good.” If I can elaborate to 20 words: “The legislation confirms the sorry state of our public deliberations, but it is probably the best that could be hoped for,” given where the negotiations were as the big hand on the clock approached twelve.
In the 1955 movie Rebel Without a Cause, James Dean and a teenage rival race two cars to the edge of a cliff in a game of chicken. Both intend to jump out at the last moment. But the other guy miscalculates, and goes over the cliff with the car.
This is the game that is being played out in Washington this month over the debt ceiling. The chance is at least 1/4 that the result will be similarly disastrous.
It is amazing that the financial markets continue to view the standoff with equanimity. Interest rates on US treasury bonds remain very low, 3% at the ten-year maturity. Evidently it is still considered a sign of sophistication to say “This is just politics as usual. They will come to an agreement in the end.” Probably they will. But maybe not. (I’d put a ½ probability on an agreement that raises the debt limit, but just muddles through in terms of the genuine long term fiscal problem. That leaves at most a ¼ probability of a genuine long-term solution of the sort that President Obama apparently proposed last week – described as worth $4 trillion over ten years.)
During much of the last decade, U.S. fiscal policy has been procyclical, that is, destabilizing. We wasted the opportunity of the 2003-07 expansion by running large budget deficits. As a result, in 2010, Washington now feels constrained by inherited debts to withdraw fiscal stimulus at a time when unemployment is still high. Fiscal policy in the UK and other European countries has been even more destabilizing over the last decade. Governments decide to expand when the economy is strong and then contract when it is weak, thereby exacerbating the business cycle.