Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities and the author of the forthcoming book “The Reconnection Agenda: Reuniting Growth and Prosperity.”
There are two competing narratives about economic policy. In one, economists have no clue how to manage advanced economies, or else we wouldn’t have faced the Great Recession, Europe wouldn’t be the basket case it is, the U.S. recovery wouldn’t have taken so long to gain traction, and middle- and low-income households would be sharing in more of the growth. Officials at the Federal Reserve would be able to decide whether inflation is a real threat or a phantom menace.
In the other narrative, the policies implemented by President Obama during the depths of the Great Recession (some of which began under George W. Bush) helped turn things around. “At every step, we were told our goals were misguided or too ambitious — that we would crush jobs and explode deficits,” Obama said during his State of the Union address Tuesday. “Instead, we’ve seen the fastest economic growth in over a decade, our deficits cut by two-thirds, a stock market that has doubled and health-care inflation at its lowest rate in 50 years.” Jobs are growing “at the fastest pace since 1999,” he said, with more created here since 2010 than in “Europe, Japan and all advanced economies combined.” And in 2014, “about 10 million uninsured Americans finally gained the security of health coverage.”
It turns out we know more about economic policy than we think we do. Much (certainly not all) of contemporary economics has a pretty good idea of how the system works and fails. Scholars understand the hydraulics, as it were, of both the macroeconomy and critical subsystems such as health care. It’s true that we often fail to apply what we know — in part because of political interference, in part because we’ve unlearned key lessons from the past, leading to mistakes such as premature deficit reduction or inadequate financial-market oversight.
But the lesson of the recovery is this: In crucial areas of the economy, we have the historical knowledge to diagnose what went wrong, and when we undertake the prescribed policy responses, they work like they’re supposed to. Conversely, when we fail to apply what we know, we hurt the economy. The Recovery Act, the financial and auto bailouts, Federal Reserve policy, and Obamacare are examples of applying the known hydraulics to achieve the intended effects. Today’s economic revival was, in the end, a victory of the technocrats.
The Recovery Act: What happened in 2008 was a collapse of demand; people stopped spending and investing money. So the prescription was a temporary boost in government spending. Shortly after the February 2009 implementation of the stimulus, real GDP swung from the 5 percent nosedive of late 2008 to a 2.6 percent growth rate in late 2009. The pace of employment losses slowed, and the unemployment rate stopped rising. The nonpartisan Congressional Budget Office found that the stimulus increased jobs and growth (though its estimates cover a range of outcomes, from economically small to significantly positive).
Equally important, when economic policy pivoted too quickly to deficit reduction in 2010, before demand had returned, growth and jobs suffered, an observation wholly consistent with our understanding of these macrodynamics. Obama officials, myself included (I was chief economist to the vice president at the time), contributed to this blunder by not recognizing the depth of the downturn; economic forecasting still belongs to narrative No. 1 — things economists do badly. Even in 2013, austere fiscal policy was holding GDP growth down by 1.6 percentage points; in 2014, fiscal policy was neutral, and the economy did much better. Again, such dynamics were knowable based on insights available since Keynes, but politics blocked us from applying them all.
The bailouts: The credit system was illiquid, meaning bad loans on their books kept banks from lending money. Simultaneously, GM and Chrysler were failing at a time when no private investor would rescue them from bankruptcy. The prescription was large injections of cash from the federal government and the Federal Reserve, along with a government-managed bankruptcy for the two auto companies.
Banks slowly began lending again, and a financial sector that was in crisis soon began to generate record profits (yes, there’s something seriously unjust about that picture). U.S. auto companies sold more than 16.5 million cars last year, the most since 2005, and after shedding jobs for a decade, the auto industry has added back more than 500,000 positions since mid-2009.
Especially for the banks, this was not the only possible diagnosis or prescription. Insolvency, conservatorship and consumer-debt forgiveness would probably have resolved the crisis more quickly and a lot more fairly, though possibly at greater government cost. But both here and in health care, politics constrained the options.
All of this — including the housing bubble inflated by reckless finance — occurred in the first place because prominent economists such as Alan Greenspan replaced the lessons of scholars such as the late Hyman Minsky, who warned of financial volatility as recoveries progressed, with those of theoreticians whose models predicted that markets would self-regulate. Now, some House Republicans are trying again to dial back the Dodd-Frank financial reforms even as financial markets are beginning to bubble, a clear example of the way politics creates a destructive wedge between our knowledge and our actions.
The Federal Reserve: Its answer to weak demand and illiquid credit markets was to lower the key short-term interest rate it controls from north of 5 percent all the way to zero, cheapening the cost of borrowing. It also signaled to investors that rates would stay at zero for a while, and when even that proved insufficient, the Fed launched other tactics, spending money on longer-term bonds (“quantitative easing”) to lower longer-term rates.
Here’s something else we know: When the Fed rate is zero and it’s still not low enough to generate the needed economic activity in the private sector, temporary fiscal stimulus — government spending — goes much further. In this case, we knew that and might have spent more on, say, infrastructure. But deficit hawks chanting the mantra of the “failed stimulus plan” prevailed, and predictably negative results (an initially jobless, and for many still wageless, recovery) followed.
Health-care reform: Ken Arrow’s classic 1963 essay demonstrated how health care is different from the rest of the economy. If you show up hungry to the supermarket, they don’t have to feed you. But if you show up sick at the ER, they have to treat you. That takes health care out of the market in ways that every other advanced economy acted upon well before we did, and thus their ability to provide quality care while controlling costs has far surpassed ours.
Once we decided upon reform — one that precluded public health insurance (again, a function of political constraints) — the course was clear. To provide near-universal coverage, the risk of illness must be pooled across the population; that means mandatory insurance, which requires subsidies for those who can’t afford it. And once the government is subsidizing private care, for budgetary reasons, it must rigorously encourage quality of care over quantity. That meant changing the way we deliver medical care in America by rewarding efficiencies (e.g., fewer readmissions, a fixed payment for a set of services).
Europe: According to recent International Monetary Fund projections, the U.S. economy is expected to grow 3.6 percent this year, while that of the euro zone is forecast to grow at one-third that rate — 1.2 percent. Its unemployment rate is 11.5 percent, compared with the U.S. rate of 5.6 percent. Thanks again to fractious politics and economic amnesia, in every area cited above except health care, European policymakers have ignored basic macroeconomics and instead pursued austere fiscal policy, refused to overhaul damaged financial and housing markets, and inconsistently pursued stimulative central banking. (They finally announced their own quantitative easing program this past week.) The results have cost their citizenry.
Here’s what we know, what we’ve (re)learned and what we still don’t understand well enough. Financial markets need vigilant oversight or they will underprice risk and generate a bubble. When private demand falters, fiscal and monetary policy must pick up the slack until demand comes back. If, during that process, the Fed’s interest rate hits zero, fiscal policy becomes even more important. Budget deficits necessarily rise as a result of these interventions — a trend we should not block in the name of austerity, because the increase is temporary.
If that reads a bit like the manual to your new microwave, well, that’s a good thing. The economy is a system, and technocrats roughly know how it works, at least the part about restoring and sustaining growth, which is why our economy has recovered while others have not.
What we don’t know enough about is how to ensure that this growth is broadly shared. That calls for another set of ideas — policies that will restore the bargaining power and educational opportunities that have eroded for middle- and low-income households in recent decades. This, too, was part of the president’s message this past week, and understandably, it’s the part that’s getting the most attention. But now that the page has turned, let’s not forget what we’ve read. We know more than we think we do about how the economy should work. We just have to put our knowledge to good use.