The economic policy memo that Larry Summers sent to Barack Obama in December 2008, and that the New Yorker’s Ryan Lizza has posted in full, is the ur-text for the Obama administration. It contains the economic team’s first thoughts on almost everything the White House would go on to do. It is, without doubt, the most authoritative guide we have to the way President Obama’s first, and arguably most crucial, decisions were framed by his key policy staffers. And it has reopened an old question about the Obama administration: Were the president’s advisers pushing him to do more or less?
The economic team clearly thought it was counseling the president to embrace a more aggressive response than anything that had previously been proposed. “We have become convinced there there is a compelling case for a recovery package considerably larger than the $500 to $600 billion that we were originally contemplating,” the memo reads. “The rule that it is better to err on the side of doing too much rather than too little should apply forcefully to the overall set of economic proposals.”
The memo also includes a comprehensive round-up of the counsel offered by outside economists on the side of the stimulus. It notes that Paul Krugman was calling for $600 billion in the first year, Robert Reich wanted $1.2 trillion over two years, Jamie Galbraith wanted $900 billion in the first year, Ken Rogoff wanted $1 trillion over two years, Mark Zandi wanted $600 billion, Lawrence Lindsay wanted at least $800 billion, and Greg Mankiw — who is now a top Romney adviser — was “the only economist who we consulted with who refused to name a number and was generally skeptical about stimulus.”
There’s an interesting backstory to that portion of the memo: When Rahm Emanuel was informed that the economic team wanted to push an $800 billion stimulus, which was larger than anything anyone else in the political system was proposing, he demanded that they get a lot of outside economists on the record with very large estimates. And so the team began doing just that.
In certain cases, Obama’s economic advisers pushed outside economists to revise their estimates of the necessary stimulus upwards. In one example, Jason Furman, deputy director of the NEC, met with liberal economist Jamie Galbraith and urged him to increase the size of the stimulus he was proposing in an upcoming speech in order to make it easier for the administration to push for a higher number. (Over e-mail, Galbraith confirmed this account.)
But the team made two huge miscalculations — one political, one economic. The political miscalculation was that “it is easier to add down the road to insufficient fiscal stimulus than to subtract from excessive fiscal stimulus.” That was clearly untrue, and a direct violation of the earlier stated precept that “it is better to err on the side of doing too much.” The economic miscalculation was that “forecasters now expect output to contract at least a five percent annual rate in 2008 Q4.” In fact, the contraction in the fourth quarter of 2008 was 9 percent — almost double what the forecasters anticipated.
The controversial takeaway from the memo is that Summers suggested that a stimulus in excess of $1 trillion would spark a counter-reaction from the bond markets. This furthers the argument that members of the president’s economic team warned him off of an appropriately sized stimulus.
“The key thing I took away from the memo is that it does not read at all like the current story the administration gives for the inadequate size of the stimulus, which is that they knew it should be larger but had to face political reality,” writes Paul Krugman. Rather, he says, “Summers et al were afraid of the invisible bond vigilantes.”
The line in question is slightly more ambiguous. “To accomplish a more significant reduction in the output gap would require stimulus of well over $1 trillion based on purely mechanical assumptions — which would likely not accomplish the goal because of the impact it would have on market.”
Summers defenders argue that he was making a more limited claim: Not that anything over $1 trillion should be off the table, but that the mechanical relationship between stimulus dollars and growth only goes so far. The fact that you can cut the output gap by half with a stimulus of X size doesn’t mean you can take the output gap to zero by doubling the stimulus. That’s not persuasive: Summers clearly argues that the bond market was to be feared. But it’s not clear what “well over $1 trillion” meant. And the fact remains that Summers and his team clearly thought they were fighting for a larger stimulus than was currently on the table, and designed the memo — complete with outside validators — to achieve that goal.
But for all the attention given to the sentence on the bond market, the memo quickly moves onto other topics. Much more attention is paid to a different constraint: the operational constraints in trying to put so much money into the economy in a way that was both quick and smart. “While the most effective stimulus is government investment, it is difficult to identify feasible spending projects on the scale that is needed to stabilize the macroeconomy. Moreover, there is a tension between the need to spend the money quickly and the desire to spend the money wisely. To get the package to the requisite size, and also to address other problems, we recommend combining it with substantial state fiscal relief and tax cuts for individuals and businesses.”
The memo deals with this question in great detail, and concludes that “we can only generate about $225 billion of actual spending on priority investments over the next two years.” The rest of the money would have to come from state and local aid and tax cuts, and tax cuts, in particular, were a less effective form of stimulus.
The administration ultimately proposed a stimulus of nearly $900 billion, which the Senate later reduced to about $700 billion (the widely quoted $787 billion total includes the AMT patch, which was unrelated to the stimulus). In subsequent deals, the administration would get around $500 billion more in stimulus, for a total of $1.2-$1.3 trillion over three years.
There are other interesting revelations in the memo, too. For instance, it notes that Phil Schiliro, the incoming legislative director, thought the TARP brand was so badly damaged that the administration should “consider repealing TARP and replacing it with a new program that we design and propose as part of the Economic Recovery program.” That suggestions was never followed up on, but it makes for an interesting what-if.