Employment Is Likely to Improve – Morale Improves When the Beatings Stop

Recovery from the employment losses suffered in the Great Recession (worker’s depression?) of 2007-2009 has been excruciatingly slow.  As I write this post in November 2013, total employment in the U.S. is still more than 1% fewer jobs than when we started this mess 5 years and 10 months ago. That’s 976,000 jobs still missing when compared to 6 years ago. Bill McBride at CalculatedRisk has been tracking this slow recovery of employment and compares it to previous (post-WWII) recessions in this graph.  Typically, we recover from a recession and re-gain the lost jobs in two years or less (2001 is the only other exception).  

Percent Job Losses in Post WWII Recessions

There are several reasons why this recovery has been so slow compared to others. The losses were deeper than the others, a financial crisis recovers slower, and households were deeply in debt which slowed recovery in spending.  But government policy is one of the most significant causes of the slow recovery.  

One of the lessons of all those earlier fast-recovery recessions is that counter-cyclical fiscal policy and automatic stabilizers work.  Yes, there are technical problems in implementing discretionary fiscal policy such as how big, when to do it, and whether to use tax- vs. spending-based policy changes. But it works -especially when the economy has a lot of slack and the recession is deep and severe.

The concept is actually very simple – if consumption spending (C) and investment spending (I) are declining, then the government needs to step in and increase its economic stimulus either by spending more and reducing taxes on those who spend.

Another lesson of those earlier recessions is that automatic stabilizers work very, very well.  Automatic stabilizers are programs like unemployment compensation, SNAP and welfare assistance, and the progressive income tax system.  The problem is that counter-cyclical fiscal policy is largely the responsibility of the national government since only the national government has the freedom to run large deficits when it’s needed.  State and local governments are constrained to run balanced budgets every year and they don’t have the sovereign power of the currency like the national government.

State and Local Government Payroll Employment

This requirement of state and local governments to always run balanced budgets means that state and local governments make recessions worse and recoveries slower. Instead of being counter-cyclical, state and local governments are pro-cyclical.  Again, Bill McBride of CalculatedRisk helps us visualize how state and local governments helped make the recovery slower.

In earlier recessions the national government would step up and offer stimulus to both offset the declines in private spending and private demand, but help fund state and local government to prevent state and local government layoffs.  That didn’t happen this time.  The national government stimulus was too small for too short of time. What’s worse, the national obsession with the deficit has led to premature austerity policies at the national level.  The result was state and local governments, instead of helping the economy recover, were effectively beating the economy for not being more robust.

The good news, though, is that state and local governments appear to finally be done beating the economy into submission.  State and local austerity is coming to an end according to the data. As McBride notes, state and local government employment rose by 74,000 in October 2013.

If this continues and state and local governments are starting to hire teachers, firefighters, and police instead of laying them off, then we will likely come closer to finally recovering all the job losses from the recession by spring 2014 instead of spring 2015.  Not surprisingly, once the beatings stop, morale actually improves.

Obama’s So-Called Keynesian Stimulus Efforts Aren’t Very

The simple version of Keynesian economics suggests that if the economy is suffering from too little economic activity and high unemployment there are some policy options.  Specifically Keynes suggests there are three general kinds of policy options:

  1. The central bank (The Fed in the case of the U.S.) could lower interest rates and create money by buying bonds on the open market.  This is called stimulative monetary policy. It is supposed to work by making private sector borrowing more attractive and more profitable so that businesses in particular increase their spending on business investment goods like equipment and factories.
  2. The government could increase it’s budget deficit by borrowing more money and cutting taxes.  This is fiscal policy by tax cuts. It works by putting more cash in the hands of households and firms (increases their after-tax income) who then increase their spending.
  3. The government could increase it’s budget deficit by borrowing more money and directly spending the money itself, either by direct transfer payments to needy individuals, or by buying things like new dams or construction projects, or by hiring the unemployed itself. This is fiscal policy by spending.

There’s nothing to stop a country from pursuing all the above options simultaneously if it chose.  But not all of these options are equal in either effectiveness.

NOTE: This is old-style John Maynard Keynes style Keynesianism, not the  “New Keynesian” theories that have dominated some academic circles in the last couple decades. It’s also based on the real thing, not the caricature that it’s opponents paint which is usually without foundation. 

NOTE 2: It’s really not a good idea to try to simplify Keynes.  When you do, you’re likely to over-simplify and really miss powerful insights and nuances.  Nonetheless, I will plunge ahead with full knowledge of the risk.

The real richness of Keynesian theory though lies not just in these prescriptions, but the analysis of when to use which one, whether it is likely to work, and under what conditions.  The first option, monetary policy, is to be preferred in cases of  mild recessions when interest rates are “normal” and the slowdown is largely for mild, temporary factors such as an outside economic shock. Monetary policy is quick and easy to implement. It’s also relatively easy to reverse course when the time comes.

Keynes had two key insights about monetary policy though that are highly relevant to our present situation.  Monetary policy can be become impotent if interest rates drop to near zero and we get into a liquidity trap.  This is when people and firms become fearful of the future and come to expect continued weakness or even GDP declines and deflation.  In a liquidity trap, people just sit on money rather than spend or invest it.  Monetary policy is relatively ineffective in such cases. We have been in a liquidity trap since late 2008 and that’s why the record 3 years of a virtually zero Fed Funds interest rate and The Fed’s QE1 and QE2 programs haven’t worked. Liquidity traps aren’t common, but they do exist and they aren’t extinct.  We were in one in the 1930’s Great Depression and Japan has struggled with one for the last 15+ years.

Keynes also had insights about the two fiscal policy approaches, tax cuts vs. increased spending.   In particular, tax cuts will only be effective to the degree that households and firms actually spend the money.  If they use the money to pay down debts or to save, then it really won’t improve conditions.  Later research in the 1950’s and 1960’s strengthened these insights. Later research showed that it also makes a big difference who gets the tax cuts and whether they think the tax cut is permanent.  Temporary tax cuts are much less effective than permanent ones because people tend to save them more.  Also, high-income individuals tend to save more of the tax cut (proportionally) than more desperate lower-income folks. Finally, later research showed that when a recession comes about because private debt got too high, then tax cuts are least effective.  Notice a pattern here?

The fiscal policy “stimulus” efforts that we have pursued since the Great Recession began have been very, very heavily tax-cut oriented.  Bush’s original stimulus effort in early 2007 in an effort to “nip the recession in the bud” was all tax cuts.  The Feb. 2009 stimulus bill of Obama (the ARRA) was between 40% and 50% tax cuts.  The meager effort passed in Dec 2010 was all tax cuts. And now, the proposal is again very tax cut heavy.  Not only have the fiscal stimulus efforts been heavily tax cut-based, but the cuts have temporary cuts targeted at either high-income folks or only offering a meager amount to low-income folks.  Further, we still have a huge private sector debt overhand that people want to pay down before they spend more. In sum, the dominant response which many have labeled as “Keynesian” really hasn’t been what John Maynard Keynes suggested. Many have asserted that “Keynesian policies don’t work” and cite our weak economy despite several fiscal policy stimulus attempts as proof.  But that’s not really a valid test.  It’s like claiming some physician is a total quack because you took pills like he recommended but you didn’t take the exact same pills as he recommended. You took something else. Now you’re still sick.  It’s not the physician’s prescription that failed, it’s your refusal to follow the prescription and the diagnosis that failed.

Critics will counter with a “yes, but there was still some spending stimulus in the Obama bills and our failure to fully recover is proof the fiscal spending as stimulus prescription is quackery.”  But have we really had an increase in government spending anywhere near large enough to fill the gap?   Let’s look at some trends (courtesy of Brad Delong):

We simply have not expanded government purchases as a share of potential GDP in this downturn:

FRED Graph  St Louis Fed 4

 

The graph shows the relative changes in share of GDP of four key portions of GDP: exports, business equipment investment, government purchases, and residential construction. (everything in the graph is scaled relative to 2005 -that’s why the lines all meet at o in 2005).  The whole Keynesian idea is that if exports, business equipment investment, or residential construction go down then government purchases should go up and vice versa.  That hasn’t happened at all.  Instead, government purchases has consistently declined since 1995!.  In other words, actual changes in government purchases have not only not been a stimulus, but they have been contractionary.  Government spending policy has been contractionary for over 15 years!  We didn’t notice it because strong increases in business equipment investment and housing were doing the stimulating prior to 2006. In the period 1995-2000, it was probably appropriate in a Keynesian sense to have declining government purchases and a contractionary policy – it was countercyclical to the dot-com boom and the housing boom.

But after 2007, residential construction collapsed. For awhile in 2009 both business equipment investment and exports declined sharply.  The only appropriate Keynesian response would have been a very, very large government purchases program.  But we didn’t do that.  Instead, the so-called 2009 stimulus bill was barely enough new spending at the federal level to offset the declines and cuts at the state and local levels. Overall, government spending did not increase. It went neutral for a couple years. But in late 2010, we resumed the march to contractionary policies.  The ARRA wound down.  State and local governments accelerated their budget cuts. And Washington became pre-occupied with imaginary threats of impossible debt crises at some point 10 years from now.

To continue the earlier physician and disease metaphor, we did try a little of the prescription but we took too little.  It’s as if we went to the doctor, the physician diagnosed a very severe infection and prescribed heavy doses of anti-biotics.  We went home took a lot of aspirin instead and only a couple of the anti-biotic tablets.  Now folks want to blame the doctor and his “failed prescriptions” when we didn’t take them.  None of this is what Keynes or 1960’s style Keynesians would have recommended. To conclude that Obama has tried Keynesian policies and they have failed is dead wrong.  The policies have largely failed to stimulate and re-ignite growth, but they weren’t Keynesian.

Government Budget Cutting SLOWS the Economy – That’s Why It’s Called Contractionary Fiscal Policy

America’s attention has been focused lately on the unnecessary debate in Congress over the debt-ceiling law.  Part of the motivation (at least the vocalized motivation) for cutting the deficit and trying to limit the national debt, according to both Republicans and the President, is that supposedly government deficits are holding back the economy. They assert that cutting the government’s spending will somehow stimulate the economy.  This is what all that Republican rhetoric about “jobs-killing spending” is about.  In more formal terms it’s referred to as a policy of “austerity”.   But it’s more than flawed thinking.  It’s flat out wrong.  Cutting government spending when there is significant unemployment and excess capacity will not stimulate the economy.  It will cause the economy to slow down and contract further.  That’s why we economists call it “contractionary fiscal policy”.

GDP, the total value of all goods and services produced, is how we measure the economy.  We can count GDP two ways.  Either we add up the total spending in the economy or we add up the total incomes (wages and profits, mostly).  Government spending is part of that spending – close to 25% in fact.  If the government spends less, it means less GDP.  It also means less income for people because what is one person’s spending is another person’s (or business’s) income.

Across the ocean, the British fell for this silly make believe idea that government austerity would create prosperity.  In 2010 they elected a Conservative government (actually a Conservative-New Democrat coalition).  The Conservatives, led by Prime Minister Cameron and Chancellor George Osborne (equivalent of the U.S Treasury Secretary), began to implement sharp cuts in government spending in mid-2010.  The results have been clear.  And bad.  The Guardian reports the results.  The British economy actually shrank by 0.5% in the 4th quarter of last year.  It barely avoided an official recession when growth in the 1st quarter with 0.5% growth. (the Brits define a recession as two negative quarters).  Now the 2nd quarter numbers are in and the economy is basically dead in the water:  0.2% annual growth rate.

 

Yes, contractionary fiscal policy, cutting the budget, is, well, contractionary. It makes things worse.  If you want to reduce government spending, do it when you have full employment, not when unemployment has been running over 9% for more than two years.  The examples are legion. Britain is only one. Three years ago Ireland thought it could budget-cut it’s way out of the Great Recession/Financial Crisis.  It only made things worse and grimmer in the emerald isle.  Austerity is making things worse for Greece.  There’s really no end to the examples.  What’s missing is any evidence from a developed country that austerity when unemployment is high actually helps.

The “Tax Cut” Bill

I have problems calling the bill currently in Congress about tax rates a “tax cut” bill.  Yes, there are some genuine “cuts”.  But most of it is fake cuts.  Congress and the Bush administration made a promise 10 years ago to raise our taxes at this time.  Now the current Congress decides to not actually do the previously-promised increase.  That’s not a real “cut” in my book, it’s a reprieve from a threat.  I mean, suppose I hold a gun to your head and promise to shoot you next Sunday. Then on Saturday, I decide to drop the gun and not shoot you for another two weeks.  Can we really say I “saved your life”?

Nonetheless, since everybody seems to want to call it a “tax cut” bill, I will too.  So what’s my take on the bill? It’s bad, very bad, and very poorly done.  But it’s also necessary at this time.  It’s probably the best we can get with this Congress and this President.

Most important, while necessary, it won’t do the job people want it to do.  People want genuine recovery. People want jobs and the unemployment rate to decline from near 10% back down to full employment (under 5% at least).  This bill won’t do that.  It’s too small.  And, it’s structured wrong.

First, it’s too small.  The biggest problem with the original Obama stimulus bill (there were several problems) was that it was too small.  It was clear by December 2008 that we needed a fiscal stimulus at least twice as big as what we got. And we needed it extended for longer. Politics triumphed and we got a bare-bones.   Instead of triggering recovery, it simply stopped the decline.  This bill repeats the mistake. While at first it looks big ($857 billion), most of it is simply perpetuating the current tax rates  – little new stimulus.  What stimulus is there, the unemployment benefits extension and the payroll tax cut (Social Security tax) amounts to maybe $200 billion or so for one year.  At best, I expect this bill to help lower unemployment to 8-8.5% during 2011.  Not enough.

Second, it’s poorly structured.  Despite the fury, rage, and disdain conservatives claim to have for “Keynesianism”, make no mistake. This is a Keynesian stimulus bill.  A poorly designed one, but one just the same.  Why?

There are two ways to implement stimulus fiscal policy: increase government spending or decrease taxes.  This bill is almost all decrease taxes.  The problem with cutting taxes as a way to stimulate the economy is basic Econ 202 principles stuff.  A tax cut may get saved, put in the bank, or used to pay down debt.  Not all of it gets spent by households.  Without the spending, no stimulus.  With this bill slanted towards tax cuts for the higher income folks it is highly likely that much of it will be saved or used to pay down debt.  The only real spending part is the extension of unemployment benefits.  That stimulus money gets spent immediately and helps generates demand for jobs.  For evidence, see here.

There are more problems with the bill, but I’m out of time right now and will address them in another post.  In particular, there are possible consequences for Social Security.

Tax Cuts, Deficits, Debt

The current bill finding it’s way through Congress from Senate to House regarding “tax cuts” will add to the deficit.  How much? $857 billion worth.  That means that this bill, which is in fact a stimulus bill, is actually a bigger stimulus bill than the one Obama and Congress passed in February 2009. The earlier bill was only in the $780 billion range spread over 2.5 years.  This is $857 billion over 2 years.

Tax Bill to add $857 Billion to Debt

by CalculatedRisk on 12/09/2010 11:10:00 PM

From Bloomberg: Senate Tax-Cut Extension Plan Would Add $857 Billion to Debt

The congressional Joint Committee on Taxation, which estimates the revenue effects of tax legislation, said the provisions would cost the government $801.3 billion in forgone revenue over 10 years. Extending unemployment benefits for 13 months, another feature of the package, would cost $56 billion, the Obama administration has said.

It is important to remember the Joint Committee on Taxation assumed all the provisions will end as scheduled; the payroll tax cut after one year, and the other tax cuts after two years. That seems very unlikely, so the actual cost will be much much higher. As an example, if the tax cut for high income earners stays in place for the next decade that will add $700 billion alone to the debt!

Also, the vast majority of the impact is from extending the Bush tax cuts.

Washington Post – FAIL on Fiscal vs. Monetary Policy

I have long observed that any students who pass Econ 201 and Econ 202 with good grades and then remember what they learned are far and away more knowledgeable about economics than the majority of Congress.  Now I must add “far more knowledgeable than the nation’s leading(?) newspaper editors.”  Observe the Washington Post in an editorial, November 21:

Yet buying hundreds of billions of dollars worth of federal debt in a deliberate effort to lower long-term interest rates and boost employment looks to many economists, market participants and politicians like fiscal policy by another name. And fiscal policy is an inherently political business.

Buying bonds as The Federal Reserve is doing with it’s QE2 program is monetary policy.  It is most assuredly NOT FISCAL POLICY.  That is by definition.  Fiscal policy is the changing of government spending and taxation (the budget) for purposes of achieving macroeconomic goals.  The Federal Reserve Bank is not the government.  The Federal Reserve bank when it buys bonds and pays for them by increasing bank reserves is engaging monetary policy.  The two are different.  Even a casual investigation of any Principles of Econ text will note the difference.  Heck, skip the text book and look it up in Wikipedia at fiscal policy and monetary policy!  Such ignorance on the part of a major newspaper is appalling. No wonder they’re losing market share.

Ireland: “Responsible” Policy Punishes Citizens for Bankers’ Sins

Poor Ireland.  For some unknown reason, the Irish seem doomed to suffer under the misguided rule of others, despite being the source of great music, culture and a brew so good      For centuries, the oppressor was the English.  In this century Ireland has fallen under the boot of the bankers and The Powers That Be (TPTB) who have have fallen under the sway of “responsbile austerity”.  There is a lesson here for America if we would only listen and pay attention.

Earlier in this century, before 2007, Ireland apparently had left it’s history of poverty and oppression to become the poster child for success via globalization. It’s GDP boomed (see graph). It attracted foreign direct investment and many foreign firms, including Google and others. It was called the Celtic tiger. GDP per capita had risen to the second highest in Europe behind Luxembourg. It was following the recommended path towards financial globalization that conservative right-wing economists have been pushing for several decades.  The right-wing Heritage foundation praised it’s financial deregulation, low tax, and nearly non-existent taxes on foreign corporations as the key to success.  And by conventional measures like GDP it appeared to work.

But in 2007, things began to turn down.   Seems Ireland had developed a highly skewed and unequal distribution of income (like the U.S. today). It had become overly dependent on a property and housing boom with 12% of GDP resulting from new construction (kinda like the U.S.).  And much of the apparent GDP increases were illusion – the result of the difference between GDP and GNP – meaning life really wasn’t as good as the GDP numbers suggested.  (See  GDP vs. GNP to learn the difference between GDP and GNP and how it distorts things for Ireland but not the U.S.).  Then the Global Financial Crisis came.  Ireland got hit pretty hard. The housing market tanked. Bank loans started going bad in large numbers.  Now it should be noted that these were all private-market loan decisions.  They were the result of foreign investors making private contracts to take on the risk and make loans to people in Ireland (and outside) to buy Irish property.  But when the loans began to go bad in large numbers, the large (mostly) Euro banks’ who had made the loans had their solvency threatened.  And with that, the profits of Euro investors in those Euro banks were threatened.  The Irish government was urged to be “responsible” by taking the responsibility away from the banks and investors who made the loans.  The Irish government guaranteed the banks’ loans after the fact.  As Paul Krugman recounts:

The Irish story began with a genuine economic miracle. But eventually this gave way to a speculative frenzy driven by runaway banks and real estate developers, all in a cozy relationship with leading politicians. The frenzy was financed with huge borrowing on the part of Irish banks, largely from banks in other European nations.

Then the bubble burst, and those banks faced huge losses. You might have expected those who lent money to the banks to share in the losses. After all, they were consenting adults, and if they failed to understand the risks they were taking that was nobody’s fault but their own. But, no, the Irish government stepped in to guarantee the banks’ debt, turning private losses into public obligations.

Before the bank bust, Ireland had little public debt. But with taxpayers suddenly on the hook for gigantic bank losses, even as revenues plunged, the nation’s creditworthiness was put in doubt. So Ireland tried to reassure the markets with a harsh program of spending cuts.

Step back for a minute and think about that. These debts were incurred, not to pay for public programs, but by private wheeler-dealers seeking nothing but their own profit. Yet ordinary Irish citizens are now bearing the burden of those debts.

When the Irish government took on the bad debts made by private banks in order to save large international investors from the consequences of their bad choices , it naturally led to a large increase in the Irish government debt to GDP ratio. So in return for the good (?) deed of rescuing international investors, banks, and bond buyers from the consequences of their investments, those investors, banks, and bond-buyers have punished the Irish government by driving interest rates on Irish bonds to high levels.  The speculators smell another Greece.  Talk of bailouts began earlier this month. And, finally with interest rates rising and the speculators circling like sharks, the Irish government accepted a “bail-out” earlier this week from the Euro central bank and IMF, the usual TPTB.

I’m not sure that it should really be called a “bail-out” though.  It’s actually a strange deal like something out of  Alice in Wonderland or a George Orwell novel.  In return for the Irish government agreeing to cut spending even more, raise taxes, and punish it’s already suffering people, the Irish government gets a large credit line so it can borrow even more money in the future.  Of course, by cutting spending and raising taxes in the middle of a serious, deep recession and when it has no control over it’s monetary policy (Ireland is in the Eurozone), it will, of course have even larger deficits than is planned or expected and will need to borrow that money.  Which will only kick the can down the road to some point in the future when another “bail-out” is necessary.  God save us all from such “bail-outs”.

What  could the do instead?  Well, first off, long-term policy should be focused on growth by investing in infrastructure and education and research, much like Finland does and not in globalization and chasing multi-national banks and corporations who play shell games.  More directly, the Irish government should consider what Iceland, that other small European island in the North Atlantic did.  As Krugman also observed in the same article:

Part of the answer is that Iceland let foreign lenders to its runaway banks pay the price of their poor judgment, rather than putting its own taxpayers on the line to guarantee bad private debts. As the International Monetary Fund notes — approvingly! — “private sector bankruptcies have led to a marked decline in external debt.” Meanwhile, Iceland helped avoid a financial panic in part by imposing temporary capital controls — that is, by limiting the ability of residents to pull funds out of the country.

And Iceland has also benefited from the fact that, unlike Ireland, it still has its own currency; devaluation of the krona, which has made Iceland’s exports more competitive, has been an important factor in limiting the depth of Iceland’s slump.

None of these heterodox options are available to Ireland, say the wise heads. Ireland, they say, must continue to inflict pain on its citizens — because to do anything else would fatally undermine confidence.

But Ireland is now in its third year of austerity, and confidence just keeps draining away. And you have to wonder what it will take for serious people to realize that punishing the populace for the bankers’ sins is worse than a crime; it’s a mistake.

But to follow the Iceland example requires two things.  First, Ireland would have to leave the Eurozone and return to issuing and controlling it’s own currency. And, second, it’s politicians would have to the well-being of the Irish people above the claims and self-interest of the banks and large international investors.  I say not gonna happen.