In some ways the data confirmed what was already known, but the numbers still shocked. We knew that house prices — the principal source of saving for most Americans — had declined precipitously and that trillions of dollars in home equity had been wiped out. But unless we understand the link between inequality and economic performance, we risk pursuing policies that will worsen both.
America has “excelled” in inequality since at least the beginning of the millennium. Inequality is greater here than in any other advanced country. The data remind us how a combination of monetary, fiscal and regulatory policies have contributed to these outcomes. Market forces play a role, but they are at play in other countries, too. Politics has much to do with the difference in outcomes.
The Great Recession has made this inequality worse, which is likely to prolong the downturn. Those at the top spend a smaller fraction of their income than do those in the bottom and middle — who have to spend everything today just to get by. Redistribution from the bottom to the top of the kind that has been going on in the United States lowers total demand. And the weakness in the U.S. economy arises out of deficient aggregate demand. The tax cuts passed under President George W. Bush in 2001 and 2003, aimed especially at the rich, were a particularly ineffective way of filling the gap; they put the burden of attaining full employment on the Fed, which filled the gap by creating a bubble, through lax regulations and loose monetary policy. And the bubble induced the bottom 80 percent of Americans to consume beyond their means. The policy worked, but it was a temporary and unsustainable palliative.
The Fed has consistently failed to understand the links between inequality and macroeconomic performance. Before the crisis, the Fed paid too little attention to inequality, focusing more on inflation than on employment. Many of the fashionable models in macroeconomics said that the distribution of income didn’t matter. Fed officials’ belief in unfettered markets restrained them from doing anything about the abuses of the banks. Even a former Fed governor, Ed Gramlich, argued in a forceful 2007 book that something should be done, but nothing was. The Fed refused to use the authority to regulate the mortgage market that Congress gave it in 1994. After the crisis, as the Fed lowered interest rates — in a predictably futile attempt to stimulate investment — it ignored the devastating effect that these rates would have on those Americans who had behaved prudently and invested in short-term government bonds, as well as the macroeconomic effects from their reduced consumption. Fed officials hoped that low interest rates would lead to high stock prices, which would in turn induce rich stock owners to consume more. Today, persistent low interest rates encourage firms that do invest to use capital-intensive technologies, such as replacing low-skilled checkout clerks with machines. In this way, the Fed may still be contributing to a jobless recovery, when we finally do recover.
Matters may get worse. The austerity advocated by some Republicans will lead to higher unemployment, which will lead to lower wages as workers compete for jobs. Less growth will mean lower state and local tax revenue, leading to cutbacks in services important to most Americans (including the jobs of teachers, police officers and firefighters). It will force further increases in tuition — data published this month show that the average tuition for a four-year public university climbed 15 percent between 2008 and 2010, while most Americans’ incomes and wealth were falling. This will lead to more student debt, more profits for bankers — but more pain at the bottom and middle. Some, seeing the consequences of their parents’ debts, won’t be willing to take on the levels of debt necessary to get a college education, condemning them to a life of lower wages. Even in the middle, incomes have been doing miserably; for male workers, inflation-adjusted median incomes are lower today than they were in 1968. Opportunity in America — already the country with the least equality of opportunity among the world’s advanced nations, where a child’s prospects depend more on the income and education of his parents then even in ossified Europe — will decline still further.
If we want recovery, there is no choice but to rely on fiscal policy. Fortunately, well-designed spending can lead simultaneously to more employment, growth and equality. Further investments in education, especially aimed at the poor and middle, from preschool to Pell Grants, would stimulate the economy, improve opportunity and increase growth. Spending a fraction of the money the federal government gave to the banks to help underwater homeowners — or extending unemployment benefits for those who have long searched but failed to find a job — would simultaneously ease the burden of those suffering from the recession and help bring the recession to an end. This higher growth would, in turn, lead to higher tax revenue, improving our fiscal position. Plenty of investments would pay for themselves.
By contrast, if we go down the path of austerity, we risk entering a double-dip recession, especially if the European crisis worsens. At the very least, our downturn would be likely to last years longer than it otherwise would. Our growth in the future will be weaker. But perhaps most important, our country will increasingly become divided, and we will pay a high economic price for our growing inequality and declining opportunity. The consequences will be even harder on our democracy, our identity as a nation of opportunity and fair play, and our society.