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When fiscal policy lags, the one-two fiscal/monetary punch doesn't land
// Jared Bernstein | On the Economy
Two recent pieces looked at where we are in this recovery and why, seven years into an expansion, we're still not at full employment. One is by my main man Josh Bivens from the Economic Policy Institute and the other is by David Mericle and Avisha Thakkar from Goldman Sachs (GS) research (sorry; no link to that one).
The figure below–not from either of these pieces–motivates the discussion. It shows three lines of real GDP: an estimate of potential GDP pre-great-recession (2007), the most recent estimate of the same, and actual real GDP (potential GDP is CBO's estimate of what GDP would be with fully utilized resources; it's the value of the economy when it's firing on all cylinders). I–somewhat artfully, you'll surely admit–call this figure: The runner who can't cross a goal line that's moving towards her.
Sources: BEA, CBO
Why is that?
The GS folks take a unique and informative approach: they compare a spate of economic indicators in the US to the "Big Five" advanced economy financial crises (taken from the work of Carmen Reinhart and Kenneth Rogoff) as well as to the 2008 European crisis economies. Basically, GS asks: how has the US recovery gone compared to prior recoveries elsewhere from financial-crisis-induced recessions? (The "Big Five" include Spain in 1978, Norway in 1987, Finland in 1990, Sweden in 1990, and Japan in 1992.)
Josh provides a different but also useful comparison: prior US downturns.
The GS team concludes that the labor market in particular has outperformed their historical comparison groups, as shown through the unemployment rate comparison below. True, our unemployment rate is biased down due to the weak performance of labor force participation and still-elevated underemployment, but as I've extensively documented, the US job market has been tightening up for awhile, driven by solid employment growth, now averaging around 200,000/month. See Bivens' Figure A on this point.
Source: GS Research
Still, as the first figure shows, the output gap is yet to close, even as potential GDP's been downgraded. That reflects both slower labor force growth (some of which is demographics but some of which is weak labor demand) and our most serious outstanding economic problem, very slow productivity growth.
What's most interesting to me about both the Bivens and GS studies is in regard to policy responses. Initially, US policy makers hit back hard with both monetary and fiscal policy. I've argued that the combination is important and complementary: monetary policy lowers the cost of borrowing but if households are both deleveraging and, based on the loss of housing wealth, suffering from lower net worth (i.e., a negative wealth effect), they're less likely to take advantage of those lower rates. That's when you need fiscal policy to put more money in people's pockets such that they'll tap the monetary stimulus. Ergo, the one/two punch.
Both studies show the following: the one/two punch of monetary/fiscal policy weakened when fiscal support for the recovery faded. The GS figure is striking (sticking with my artful theme, let's call it Paul Krugman's nightmare). Fiscal support started strong both here and in Europe, as did (see second figure) monetary policy (the negative numbers reflect the Fed's lowering and holding down the Fed funds rate). But while the monetary authorities kept their stimulus going, austere fiscal policy kicked in with a vengeance.
Source: GS
Source: GS
Bivens austerity figure is also illuminating, and includes all three levels of government spending (fed, state, local).
Source: Bivens
Over to Josh:
[The above figure] shows the growth in per capita spending by federal, state, and local governments following the troughs of the four recessions. Astoundingly, per capita government spending in the first quarter of 2016—27 quarters into the recovery—was nearly 3.5 percent lower than it was at the trough of the Great Recession. By contrast, 27 quarters into the early 1990s recovery, per capita government spending was 3 percent higher than at the trough, 23 quarters following the early 2000s recession (a shorter recovery) it was 10 percent higher, and 27 quarters into the early 1980s recovery it was 17 percent higher.
His judgment is harsh and unequivocal…practically Old Testament:
If government spending following the Great Recession's end tracked spending that followed the recession of the early 1980s for the first 27 quarters, governments in 2015 would have been spending an additional trillion dollars in that year alone, translating into several years of full employment even had the Federal Reserve raised interest rates. In short, the failure to respond to the Great Recession the way we responded to the other postwar recession of similar magnitude entirely explains why the U.S. economy is not fully recovered seven years after the Great Recession ended.
I think that's probably right and I also think it helps to at least partially explain what may be the most negative development in any of the above pictures. I'm gonna let you guess what that is…I'm waiting…hint: it's in the first figure.
It's the sharp decline, from the 2007 to the 2016 vintage, in CBO's estimate of potential real GDP. Hard to believe that downshift is a demographics story, because CBO estimators knew the population's demographics back in 2007, when they had potential growing a lot more quickly. In fact, CBO assigns most of the reduced potential to "reassessed trends:" a more pessimistic outlook re hours worked and productivity than what they believed before the crisis. By taking half the punch out of the one/two fiscal/monetary punch, dysfunctional and mindlessly austere policy makers have contributed to the loss of hundreds of billions in value-added.
Still, sticking with the first figure, soon the aging runner will likely finally cross the goal line, and we're doing better here than most other advanced economies. We're nudging towards full employment and I'm even finally seeing a little pressure on wages. But it would be foolish to ignore the mistakes we've made and what they're actively costing us in lost output, jobs, and living standards.
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