The centerpiece of the jobs plan unveiled by President Obama Thursday night—the extension and expansion of payroll tax cuts to employees totaling $175 billion—has turned out to be among its most controversial aspects. Indeed, policymakers and commentators from across the political spectrum have argued that its stimulative effects could be negligible. A continued payroll tax break, they say, would increase our deficit and put the solvency of Social Security in jeopardy, without lowering unemployment or leading to any significant immediate increase in consumption.
These criticisms miss the mark. A cut in payroll taxes is rightly at the center of the government’s jobs proposal, precisely because the type of stimulus it will create is not immediate.
It’s true that many workers are likely to initially save at least part of the extra money in their paycheck that will appear as a result of a payroll tax cut. That will ultimately help solve the problem that has been the greatest drag on national growth: The enormous debt that burdens middle class households.
Consumption is by far the largest share of the American economy, comprising 70 percent of GDP. Indeed, it’s possible to track the story of our current recession in our consumption rates: It has increased by a well-below average rate of two percent in inflation-adjusted terms over the past year.
It’s important to realize that the real reason consumption has been increasing at only a modest rate is that many families are working hard to lower their debt loads rather than continue to spend like they used to. And with good reason. The middle class is still trying to rebuild trillions of housing and stock market wealth lost during the financial and housing crises in 2007 and 2008. Middle class wealth diminished precipitously because of the drop in house values and stock portfolios, but families still owed the mortgages they borrowed against those houses to finance their spending during the good times.
As long as those debts are at an unmanageable level, it won’t be possible to increase consumption in sustainable fashion. At the current rate, however, it will be many years before private debt levels shrink sufficiently. Families owed about 90 percent of their after-tax income on average in the 1990s, the last business cycle before the mortgage boom. At the current rate of deleveraging it would take more than five years to just get back to that level—never mind the lower debt levels of the 1970s and 1980s.
In the next several years, however, faster deleveraging won’t be possible unless incomes grow more quickly. (Faster income growth helps deleveraging since leverage is the ratio of debt to income: As long as income is increasing, in other words, leverage falls, even if total debt stays the same.) Total after-tax income has indeed grown since the recession officially ended in June 2009, but at a very low 4.8 percent. More typical income growth of ten percent for a period of seven quarters would have brought down families’ leverage below 109 percent; normal income growth, in other words, would have already naturally lowered leverage by about the same amount that it would take current American families, with their strenuous saving, to accomplish in a year’s time.
Raising income growth, then, is the necessary condition to getting families out from under their crushing debt burden and to getting the rest of the economy back on track: It’s only private deleveraging that can speed up the return of healthy growth and steady job creation. The alternative is that household debt will continue to put a drag on consumer spending increases and job growth, regardless of what other stimulus measures we devise.
Federal policy can make a difference, however. The government has tools at its disposal to lower the ratio of debt to after-tax income, thus alleviating the pressures on the middle class. That said, not all forms of government-sponsored deleveraging are created equal. The government is right to focus on middle class tax cuts as a large part of the jobs package. The debt burden is largest among moderate-income and middle-income families, and it’s difficult to design spending measures to target moderate and middle incomes. Maintaining and expanding the payroll tax holiday that expires at the end of the year seems, in many ways, the best way to foster faster deleveraging.
Indeed, the great thing about the payroll tax cut is that it allows us to have our cake and eat it, too. With the effective increase in their incomes, consumers will be able both to save more and spend at a faster rate: Faster income growth will allow families to reduce their debt burden (the ratio of debt to after-tax income) and thus facilitate spending and saving at the same time.
Moreover, the extension of the payroll tax cut will give momentum to a process that is already underway. Families have already made progress on easing their debt burden. The ratio of debt to after-tax income stood at a record high of a little over 130 percent in September 2007, just before the economy tanked. It had fallen to about 114 percent in March 2011. Banks that had tightened their purse strings to the middle class are beginning to ease up. The country’s unprecedented wave of home foreclosures has allowed a lot of extant debt to be written off. Low interest rates have made it easier for families to shoulder their debts. (And President Obama has already proposed policies to help families refinance faster to take advantage of these historically low interest rates, though the benefits from that move, although a welcome step to further deleverage households, are limited given that interest rates are already at rock bottom.) The only way to further speed private deleveraging, in other words, is by increasing the income growth of America’s middle class.
President Obama’s proposed payroll tax holiday does just that. Indeed, it does more. By easing the debt burden that families feel, President Obama’s tax cuts would not only not only foster immediate consumption, but sustainable and long-lasting economic growth.
Christian E. Weller is an Associate Professor at the Department of Public Policy and Public Affairs, University of Massachusetts, Boston, and Senior Fellow, Center for American Progress, Washington, DC
In his book The Greatest Generation, Tom Brokaw paid homage to the generation that emerged from the Great Depression to fight Hitler and other forms of tyranny. Their efforts were all about sacrifice so that their children could enjoy a better life. They sacrificed on the front lines of battle and back home in the factories that produced what was needed to wage war.
We, on the other hand, are members of the Baby Boom generation (the authors are both 60 years old)—a cohort that is hardly known for its selflessness—and we can’t help but wonder: What, exactly, happened to the children of the “Greatest Generation?” Where is our willingness to sacrifice so that our children can enjoy a life even better than ours?
With Congressional Republicans blocking any further fiscal stimulus, it falls on the Federal Reserve to do what it can to reduce unemployment. Those opposed to the Fed doing so express concern that it would spark inflation. We should be so lucky. A moderate increase in inflation, contrary to the overblown fears of inflation-hawks, would be a boon to the economy. And while it’s not a guarantee that our central bank actually has the ability to spark inflation right now, it’s clear that they should be employing all the weapons in their arsenal to try.
This article is a contribution to 'Is There Anything That Can Be Done? A TNR Symposium On The Economy.' Click here to read other contributions to the series.
As the Great Recession drags on and on, it’s natural to wonder if we will ever get back to normal. Why is the recovery from this recession taking so long? Why was the recovery from other severe recessions, for example the 1982 recession where unemployment reached 10.8 percent, so much faster? Part of the answer is that we are experiencing a “balance sheet recession,” and this type of downturn is much harder to recover from than the other types we have had in recent decades. But poor policy is also to blame. Unfocused stimulus packages don’t get to the root of the problem, and short-term spending cuts are counter-productive. Instead, we need policies that do a better job of targeting the specific problems associated with balance sheet recessions. There are several things policymakers could do to address this, and each would help to improve the economic outlook.
This article is a contribution to 'Is There Anything That Can Be Done? A TNR Symposium On The Economy.' Click here to read other contributions to the series.
There are two facts about our current economic situation that can no longer be denied: Our economy is in desperate need of government stimulus, and our political system won’t abide any increase in our national deficit.
Taken together, the two points seem to bode poorly for the United States. But we shouldn’t be too quick to assume a contradiction. Just because stimulus has traditionally been understood as a function of deficit-spending doesn’t mean that’s how it has to work.
We first have to come to grips with the fact that we need stimulus because we’re facing a problem of inadequate aggregate demand, a concept that we owe to the work of John Maynard Keynes. Keynes pointed out that a national economy can get stuck in a bad equilibrium—as it had in the Great Depression in 1930—where unemployed people really wish to supply their labor to some employer, but employers won’t hire them because they don’t think that the extra product they would make could be sold. Why not? Because of all the unemployed people trying unsuccessfully to supply their labor who can’t afford to buy anything. And why aren’t they working? Because no one will hire them.
That sounds circular, but that was exactly Keynes’ point. The whole depression situation is just an absurd circularity that we get stuck in from time to time, and can stay stuck in for a very long time. The core idea of Keynes’ theory is that there’s no fundamental reason to be in such a weak economy except the fact that we’re in it.
The problem is essentially one of communication: Somehow the unemployed have to communicate—not just in words but in the marketplace—their desire both to supply their labor and also to buy the excess of goods they would produce with the income from that labor. Part of Keynes’ idea, not always explained in the subsequent discussions of the theory, is that what has to be communicated is not any objective facts or information, but an intuition—a sense of confidence, a sense that the worst is over, a sense that the people’s animal spirits are back. If we think confidence is returning, then confidence will return.
The medium through which that communication largely needs to occur is collective action. We need to assert as a nation our will to get out of the bad equilibrium and get moving. And the way to do that is through government stimulus: We need to increase government expenditure for as long as it takes to break out of our rut. And there’s no use denying that those government expenditures will need to increase substantially in order to reduce the unemployment rate measurably.
That brings us to a critical fallacy that has crept into our thinking: We have become habituated to the idea that Keynesian fiscal stimulus has to take the form of deficit spending. After a credit downgrade by S&P, there’s a strong argument to make that the U.S. government is in no position to make a massive further increase in the national debt—but that's not an argument against stimulus as such. The fallacy is to think that stimulus necessarily needs to run up the national debt.
In reality, stimulus can easily take a balanced budget form: The government can simply raise taxes and raise expenditures by the same amount. The idea that balanced budget increases could save an economy stuck in a bad equilibrium goes back to the work of economists Walter Salant and Paul Samuelson in the 1940s, and it’s been taught in introductory economics courses ever since, though somehow it has been absent from public discussion of the current economic situation. Salant and Samuelson argued that in a very weak economy the balanced budget expenditure increases would translate into a one-for-one increase in national income.
In fact, the returns on a balanced budget stimulus are likely to be even greater than that. If the government raises taxes to hire the unemployed, then the unemployed who now get jobs will likely quickly spend all the money they earn on new consumption, since they have been strapped and now have jobs. The currently employed, who will see their taxes go up, will likely not cut their expenditures as much because they are habituated to their current level of consumption. And it is unlikely that a balanced budget stimulus would “crowd out” private expenditures on goods and services by pushing up interest rates. The Fed has already committed itself to keeping interest rates at zero until 2013.
The big problem with balanced budget stimulus is political, namely that there is a huge opposition to tax increases right now, primarily among Republicans. But their resistance might be softened if they were made aware that a balanced-budget stimulus would not lower average after-tax income: Every dollar of increased taxes could go toward giving someone extra income. (Though it's true that the people who would see their taxes increased the most are not likely to be the same people who would see their income increased.) Moreover, any public concerns about the high national debt should easily be allayed by the balanced budget stimulus, as it would probably lower the debt to GDP ratio by raising the denominator (GDP) without increasing the numerator (debt).
The balanced budget stimulus could also be designed in such a way as to avoid substantially increasing the size of the government. People often seem to think that government expenditures on stimulus means hiring people to sit at a desk at a government agency, or to clean up trash in the local national park. But that is not at all the way it has to be.
In enacting the stimulus, we could take as our model the National Science Foundation, through which the federal government sponsors scientific research. The government does not hire scientists directly through the NSF. Instead, it makes grants to individual scientists in universities and research facilities. The choice of who gets what grants are largely made by panels of non-government scientists who are called in to help the NSF evaluate the grant proposals. Those procedures could easily be extended beyond scientific research to other industrial areas.
Ultimately, if we did enact a balanced budget stimulus, we would still face the problem of how to find suitable projects to spend government money on. Designing and vetting projects takes time: A single construction project can demand years of planning and permitting. So the first step should be to immediately get going on the planning, even before we've gotten the resolve to do any additional stimulus.
(My colleague Martin Shubik, now an emeritus professor of economics at Yale, has proposed a sustainable solution to this latter problem—namely, a Federal Employment Reserve Authority, a permanent new government agency that would continually be in the business of creating a list of public works projects that are ready to go should there ever be a steep economic downturn. It would resemble a federal agency created in 1941, the Public Work Reserve, which was created to address the risk that the U.S. economy might fall into depression again after the economic stimulus of wartime spending was over.)
The essential idea, again, would be to raise taxes and raise expenditures, simply for the duration necessary to push us out of our current bad equilibrium. For plenty of policymakers, the phrase “tax-and-spend” has become a four-letter word, but it might just offer the optimal solution to our present crisis.
Robert Shiller, a professor of economics at Yale University, is the co-author, with George Akerlof, of Animal Spirits.
This article is a contribution to 'Is There Anything That Can Be Done? A TNR Symposium On The Economy.' Click here to read other contributions to the series.
Most adults know that there is no Santa Claus. They should also know that there was no stock market crash associated with Standard and Poor’s downgrade of U.S. government debt. However, because powerful interests want to spread misinformation about the downgrade, people are likely to be much better informed about Santa Claus. Righting public perception about this recent history isn’t just an idle exercise—it’s the only way to keep our social welfare programs off the chopping block.
Once the S&P downgrade happened, politicians were quick to link the agency’s decision to the tumult in the stock market. However, a little common sense shows that this chain of logic is simply not true. The S&P downgrade was most immediately a statement that U.S. government debt is more risky than had previously been believed. If anyone took S&P seriously, then it would mean that they attach a higher risk premium to holding U.S. government debt. This is the exact opposite of how the financial markets reacted, however. Bond prices soared as the yields on U.S. Treasury bonds fell to near record lows. It was as though the markets with one loud yell screamed out “we spit on your downgrade, S&P!”
So why did the stock market plunge on Monday? Most people in Washington don’t know about it, but there is a currency across the Atlantic called the “euro.” The euro was on the edge of collapse because the debt crisis that was affecting some of the smaller governments was spreading to eurozone giants such as Spain and Italy. It will be very expensive to support the debt of these countries. On the other hand, if they are allowed to default it would be a massive blow to the European banking system. This would likely set off the same sort of chain reaction and freezing up of the financial system that we saw after Lehman collapsed in September of 2008. It is not surprising that the very realistic fear of another worldwide financial collapse would send the stock market tumbling.
Instead of accepting these basic facts, however, many politicians and people in the media were anxious to push the downgrade-market crash story to advance their agenda. The moral of their story is that we got a huge market plunge because we did not reduce our deficits enough, forcing S&P to downgrade the government. If we don’t straighten up and take our medicine, then S&P or one of the other credit agencies may do it again, and then we will get an even bigger market hit.
This narrative quickly leads to the conclusion that we have to cut Social Security, Medicare, and Medicaid, the huge social welfare programs that most of the working population either depends on now or expects to in their retirement. These are hugely popular programs among people of all ideologies, including Tea Party Republicans. Few politicians want to be associated with major cuts, but if the markets will crash unless they do something, then there really is no choice.
As a practical matter, the stock market actually has little impact on the economy. Firms rarely rely on stock issues to directly raise capital for investment. More typically, shares are issued to allow the original investors to cash out. The main impact of the stock market on the economy is through its effect on consumption. Economists generally estimate that an additional dollar in stock wealth will lead to 3-4 cents in additional consumption. This means that the $2 trillion lost at the low of the market would eventually imply a drop of $60-$80 billion in annual consumption (or 0.4-0.5 percent of GDP) if the market stayed at its bottom (and it didn’t). That’s not trivial, but it’s hardly a disaster even in an economy as weak as ours.
The real story of the stock plunge, then, is that it matters hugely to that small segment of the population that has substantial sums invested in the market. While less than one quarter of the population owns more than $25,000 in stock (including indirect investments though mutual funds and 401(k)s), virtually all the people involved in national economic debates fall into this category. This includes economists, reporters with major news outlets, and senior congressional staffers and their bosses. The stock market may not matter much to the economy, but it matters hugely to the people who make economic policy.
This is why the fraudulent story of the S&P stock market crash is so important. Those pushing this line know that if they can get it accepted, cutting Social Security, Medicare, and Medicaid is a done deal. While most politicians don’t want to be seen cutting these programs, they just might if they believe it would be an economic calamity if “we” didn’t step up to the plate and take the medicine. There is nothing more dangerous than a rampage of frightened policy wonks.
This means that we have to tell our stock market-addicted politicians and policy makers that it wasn’t the downgrade that sank their retirement funds. If they are concerned about their 401(k)s, they should demand stronger measures from the European Central Bank to support the euro.
Dean Baker is the co-director of the Center for Economic and Policy Research. His most recent book is False Profits: Recovering from the Bubble Economy.
This article is a contribution to 'Is There Anything That Can Be Done? A TNR Symposium On The Economy.' Click here to read other contributions to the series.
The persistent sluggishness of the recovery here in the United States and in most of the world’s advanced economies should underscore a stark lesson from economic history: Systemic financial crises are the products of deep economic problems, and they can’t be solved by simply treating the after-effects of slow growth. It’s long overdue that the United States and Europe directly address the deep market distortions that brought about the crisis of 2008 and 2009.
So far, all we’ve done is substitute large doses of fiscal and monetary stimulus for the hard work. We shouldn’t have been surprised that once the stimulus played out, the same distortions reasserted themselves. We may technically be experiencing a recovery. But unless we’re more forthright in our interventions into both the housing and financial markets—on both the international and domestic stage—we’ll remain exposed to the possibility of a renewed crisis, one even more severe than the one that began three years ago.
These considerations don’t drive policy, in part because so many economists still see the crisis as an anomaly, one that will be followed in due course by markets reasserting their natural optimality. This view, of course, ignores or slights the overwhelming evidence of how inefficiently and “sub-optimally” the financial and housing markets have performed for years. U.S. and European financial markets have systematically failed to reasonably price the risks of trillions of dollars of derivative securities; housing markets here and across much of Europe have sustained a classic speculative bubble and equally classic crash. Our current predicament has as much to do with our own lame responses to the consequent crisis, as it does with the original crisis itself. Washington provided bailouts and virtually-free credit for financial institutions without applying requirements to how that new-found money ought to be used. There also were new housing initiatives, but based on a fanciful view that a little federal money would be enough to convince bankers to extend new credit to people on the brink of default. Finally, there was a substantial fiscal stimulus cobbled together from the wish lists of hundreds of members of Congress.
The results are now clear in the data. Financial institutions amassed trillions of dollars without expanding business lending, mainly because the financial-market distortions that brought on the crisis are still with us. These institutions are still holding trillions of dollars in wobbly asset-based securities, whose risks even now they cannot reasonably price. So they sit on most of their new capital (after paying out their bonuses) in hopes of avoiding another bout of bankruptcy from those assets, should another crisis erupt. Yet, the prospect of new legislation to sustainably resolve those weak assets by pulling them off the books—as Sweden did in its early-1990s banking crisis, and we did in the S&L crisis of 1989-1990—is nonexistent.
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