Each chapter of the book is devoted to a policy idea to address these two fundamental problems: the inequality-induced gap between growth and prosperity, and the absence of full employment. The last chapter, which I’ll feature here at some point, argues for a politics that will support a reconnection agenda, and suggests that such a politics may not be as far away as you think.
One final bit of throat clearing: I’ll be on a panel in D.C. discussing my book at what promises to be a great event on these sorts of issues on the morning of March 30, featuring former Fed chairman Ben Bernanke as the keynote speaker.]
Summary of Chapter 4:
Fiscal and Monetary Policies That Work for Working People
In modern, advanced economies, two of the biggest tools to achieve full employment are fiscal and monetary policy. And since we’re trying to put the right tools in the reconnection agenda toolbox, these two are the most essential, the veritable hammer and drill, the tools without which we would be unable to reconnect growth and more broadly shared prosperity.
Fiscal policy is taxing and spending, something with which we’re all pretty familiar. While we often associate fiscal policy with raising the necessary resources to support major social insurance programs like Medicare and Social Security, defense, our public infrastructure, and public education, the part that’s most critical to the reconnection agenda is stabilizing the economy when markets fail. It’s also the part that major advanced economies have been getting wrong in recent years at tremendous cost to their citizens (i.e. austerity, or fiscal consolidation in weak economies).
While monetary policy may seem a bit more mysterious, it’s really nothing more than the actions of the nation’s central bank — that’s our Federal Reserve, or the Fed — to try to control two opposing forces: unemployment and inflation. Though the negative correlation between these two variables has lessened in recent years (meaning they’ve become somewhat less likely to move in opposite directions), it is still generally the case that slack in an economy — e.g., weak demand, lots of people out of work — leads to lower price pressures, or less inflation, and vice versa.
The Fed’s main tool in its efforts to manage its dual mandate — maintaining both full employment and stable prices — is the interest rate it controls called the federal funds rate. Based on its extensive analysis of the economy — the Fed employs more than 300 economists . . . what could go wrong? — the Fed adjusts that rate up to slow growth and inflation, and down to try to speed it up.
The chapter stresses the interaction between these two policy behemoths, arguing strongly against the notion that Fed policy is all we need. In economic slumps and periods of weak demand, where unemployment and wealth losses drive weak job and wage growth, the Fed can and does lower the cost of borrowing so businesses and households are incented to take on new investments. But there are two problems.
One, the Fed controls a powerful interest rate tool, but once it hits zero, which is where it has been stuck for more than five years as of early 2015, it’s far less effective. Two, absent more income growth, even at zero interest rates, people are less likely to take advantage of cheap loans.
That’s where fiscal policy comes in. The chapter argues that fiscal and monetary policy must work together to be most effective. Monetary policy sets the table but it takes fiscal policy to bring people into the restaurant. I show evidence of their joint effectiveness during the early years of the downturn, but equally compellingly, I provide evidence of the very negative outcomes that occurred when we prematurely shut down the fiscal side of the equation.
Not only are fiscal and monetary policy thus absolutely essential tools in the reconnection toolbox, their complementarity is likely to be increasingly important in the future. Low interest rates at the Fed and across much of the global economy suggest that the “zero lower bound” problem is not nearly the anomaly most economists thought it was, meaning fiscal policy will need to step into the breech when the federal funds rate is stuck at or near zero.
With that possibility in mind, the chapter argues that there are a variety of ways to ratchet up the effectiveness of both fiscal and monetary policy when it comes to getting to full employment. These include fiscal triggers based on not just the unemployment rate but broader indicators of state economic conditions, wage (vs. unemployment rate) targeting at the Fed, running a tight enough job market to pull sideliners back in (i.e., those who’ve left the labor market but would come back in the face of stronger labor demand), and a people’s campaign such that folks from all walks of life can interact with an institution — the Fed — that has real sway over their economic lives.