More than 100 economists and historians have now signed The Daily Beast manifesto calling for tax cuts and stimulus spending to reboot America, even as the proposal triggers a fierce debate among their colleagues. Walter McMahon, an economist and professor at the University of Illinois, shares his own ideas on how to stave off a double-dip recession. Plus, read the complete list of manifesto backers.
The confusion about how the economy works in the press and in the public mind is massive, and very worrisome. It could lead to a real tragedy of a double dip recession, and the kind of stagnation that Japan experienced in the 90's. Economists need to encourage our leaders to get onto the talk shows and use the bully pulpit to educate the public (plus Representative Boehner) on a few simple points.
For one thing, if there is no deficit, there is no stimulus. “Paying for” extending unemployment benefits, for example, with something that removes an equal amount of purchasing power results in no net increase in the demand for products. It eliminates the effectiveness of unemployment compensation as a built in stabilizer.
• 101 Economists Sign Daily Beast Manifesto• Read original manifestoFor another, small businesses are not going to “create jobs” unless there is demand for their products. Businessmen are wise, and even though interest rates may remain very low, as they are now, they will not borrow to invest in capital goods or create jobs even with subsidies if there is insufficient demand for their product. The demand for labor, and job creation, is a derived demand, derived from the demand for their product.
Government expenditures financed by borrowing put purchasing power in the hands of the recipients who then buy products, including products from small businesses, thereby creating jobs.
Still another source of confusion is the distinction between a short-term deficit, and the longer-term projected secular deficit. The short-term deficit is badly needed to continue to stimulate demand and help along this very fragile recovery, probably into 2011, whereas the secular deficit due primarily to the projected exponential upward curve in Medicare and Social Security costs as the population ages is a serious problem. There is need to start to work on the latter or rational expectations focused on this will take over. But to confuse this with the former and reduce the short-term deficit because of this confusion will restart the recession, a true disaster.
Furthermore, it is totally unrealistic to expect the job market to respond rapidly. There has repeatedly been a lag of about 1.3 years after the trough of a recession (in this case the last week of July in 2009 following the passage of the stimulus package in February) and the decline in unemployment. This is the way the economy works. It is like a huge ocean liner that has no side propellers and cannot turn around on a dime, but takes a two-mile arc to turn 180 degrees. Many are being totally unrealistic to expect anything different. There are huge mortgage and home equity debts, consumer credit debts, and overbuilt housing and office space to begin to work off. That takes time before the multiplier effect fully kicks in with private sector job creation.
Finally, with massive unemployment continuing, it is not the time to balance central government budgets because of predicted inflation. Wait till the job market starts to tighten, and money wage inflation rises, then the Fed will raise interest rates and choke off inflation. And then budgets should move toward balance. But citing rational expectations both ignoring this response by the Federal Reserve and ignoring the fact that most markets (labor markets, products markets, and even money markets) have a large adaptive expectations component merely reflects the interests of bondholders. The latter are not much concerned about unemployment. It is a scare tactic without much basis in the real world.
The greatest threat to our economy is confused thinking by an influential few. Economists have a responsibility to do what they can to straighten this out.
Click here to read the original manifesto and the full list of economists who've signed on.
Walter McMahon is an economist and professor at the University of Illinois.