For years, central bank officials have complained that expectations that they can single-handedly revive the nation’s anemic economy are misplaced. The Fed can only set the stage for stronger growth; Congress must also play its part. But between fiscal cliffs and debt ceiling standoffs, lawmakers instead seem to be intent on shutting down the entire production.
A new initiative by the left-leaning Center on Budget and Policy Priorities launching today is refocusing on the role of fiscal policy in returning the country to full employment. The project is spearheaded by Jared Bernstein, a senior fellow at the center and former economic adviser to Vice President Biden. The initiative kicks off with papers by several top-tier economists, including one by Laurence Ball at the National Bureau of Economic Research, Brad DeLong at the University of California-Berkeley and former U.S. Treasury Secretary Larry Summers that argues fiscal austerity actually worsens recessions and prolongs the damage to the labor force.
Their paper concludes that because the Fed has slashed interest rates down to zero, the United States should be pursuing expansionary fiscal policy to get the most bang for its buck. In other words, the timing (from a macroeconomic standpoint, though perhaps not a political one) for fiscal stimulus is ideal.
The benefits from such a policy greatly exceed traditional estimates of fiscal multipliers, both because increases in demand raise expected inflation, which reduces real interest rates, and because pushing the economy toward full employment will have positive effects on the labor force and productivity that last for a long time.
We argue that in a liquidity trap environment like the one we are experiencing at present, properly designed fiscal stimulus is likely to reduce rather than increase the long-run debt burden. This outcome reflects a combination of (1) the direct benefit of stimulus in raising revenues; (2) the favorable impact of increased gross domestic product in reducing the debt/GDP ratio; (3) the possibility that fiscal stimulus today reduces future spending burdens, such as the cost of deferred maintenance; (4) favorable supply impacts of public investments; and (5) possible reductions in real interest rate costs that come from increases in expected inflation.
Typically, fiscal stimulus has a muted effect on employment and productivity because a higher national debt burden would just weigh on future growth, the authors note. But interest rates are not zero in a typical economy -- and that means fiscal stimulus can have a very different effect, they argue.
A study by the International Monetary Fund last year found that the organization incorrectly forecast GDP for several advanced economies because it underestimated the impact of fiscal policy. Advanced economies that engaged in cost-cutting during the financial crisis in 2009 and 2010 suffered bigger hits to economic growth than the IMF expected. On the flip side, the authors of the CBPP paper say expansionary fiscal policy would result in a significant swing in the other direction. The other papers being presented in the CBPP’s initiative tackle more specific policy prescriptions, including the role of manufacturing, work-sharing programs and paid apprenticeships.
But might it already be too late for such a discussion? Congress’ greatest fiscal achievement was simply getting out of the way of the recovery. The Fed is not only reaching the limits of its firepower, but also preparing to sheathe some of its weapons. Former Chairman Ben S. Bernanke tried to warn lawmakers years ago that the central bank could not do the job alone.
“Monetary policy is not a panacea,” he said in June 2011.
Bernanke said it again in July 2011, October 2011, February 2012, July 2012, October 2012, November 2012, February 2013 and July 2013, with slight variations in wording. But who’s counting? Certainly, no one -- at least in Washington -- was listening.