The Federal Reserve’s decision Tuesday to buy up long-term government debt won’t solve our economic woes, says Nobel Prize-winning economist Robert M. Solow. Instead, we need more stimulus spending and tax cuts, as called for by economists and historians in The Daily Beast manifesto and read the complete list of manifesto backers.
In a market economy, stuff gets produced, capacity grows, and people are employed when businesses see a decent chance to make strong sales and good profits. Right now, they see no such thing. Our economy is limping along, growing slowly—too slowly to make up much of the ground lost in the long, grinding recession. The members of the Federal Reserve Board expect that the unemployment rate will still be above 7 percent in 2012. (It was 4.6 percent in 2006 and 2007.) We are wasting productive capacity, eroding skills, and damaging families.
To coin a phrase, we need to get our economy moving again, and soon. It would be foolhardy to sit and wait for a spontaneous burst of consumer spending or business investment in a sluggish economy with high unemployment and with capacity utilization still only halfway back to its pre-recession level. Not much more can be expected of monetary policy. It has done what it conventionally does, and continues to keep interest rates low. Lending by commercial banks is still falling slowly, as banks try to rebuild their capital positions, and have a hard time finding promising borrowers anyway. The Fed is pursuing some less-conventional devices for giving the economy a push, but in present circumstances it is pushing on a string.
That leaves a choice between prayer and fiscal policy. The federal government could give the economy a starting push either directly through increased public spending or indirectly through carefully targeted tax reductions. The early 2009 “stimulus package” amounted to much less than its price tag. It was too small for the oversize demand deficiency it was supposed to cure, and it was very badly composed. For example, the evidence tells us that universal one-time tax rebates tend to be used for debt reduction or otherwise saved. And many of the spending items, even if devoted to some worthy object, had little job content and played out over much too long a time, when what was needed was a strong, front-loaded but steady push.
There is still time and need for further stimulus, of serious magnitude, and this time directed in a way that will lead reliably and quickly to spending on goods and services. Spending is what business needs to see. An obvious candidate is financial assistance to state and local governments. Their revenue has been decimated by the recession, they have limited borrowing capacity, and as a result their spending is now lower than it was three years ago. Federal aid would be spent promptly on established services and transfers to the needy. A determined search would find other opportunities. This time, any tax reductions should go to those who can be counted on to spend the proceeds: mainly the unemployed and the working poor.
A functioning democracy has to understand that sometimes the short-run and long-run needs are different. Today, in a depressed economy, we need more spending.
• Read The Daily Beast ManifestoOf course further stimulus will increase a federal budget deficit that is already very large and will persist for years. It will persist even longer if the economy remains weak. That is cause for thought, not for paralysis. In the longer run, the build-up of Treasury debt displaces corporate securities from portfolios and raises the cost of borrowing to active businesses. But right now it is not borrowing costs that deter productive investment; it is the lack of demand for the products of those businesses. A functioning democracy has to understand that sometimes the short-run and long-run needs are different. Today, in a depressed economy, we need more spending. When prosperity returns, we may need more saving to finance domestic investment. The right response is stimulus now plus a credible plan to decrease the debt/GDP ratio when unemployment and idle capacity have been reduced to acceptable levels. Unfortunately the federal government doesn’t have much credibility these days. An intelligent, non-suicidal recovery plan might actually help.