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We’d better get ready for the next recession: Lessons from the Recovery Act on its 7th anniversary

Speaking to workers at a construction site in Clermont, Fla., Vice President Biden discusses Recovery Act projects for transportation and infrastructure and their impact on jobs in the Orlando area. (Associated Press)

Seven years ago Wednesday, less than a month into the new president’s first term, a functional Congress passed the American Recovery and Reinvestment Act (ARRA) in response to the Great Recession. Vice President Biden, who will commemorate that achievement Wednesday in New Orleans and Memphis, was appointed by the president to be implementer-in-chief, and, as we report below, his efforts (along with those of the Federal Reserve) paid off. (Disclosure: One of us, Bernstein, was Biden’s economic adviser at the time.)

Why does this anniversary matter? Some might be wondering, given recent headlines that tell of market swoons, global leveraging and higher recession probabilities, whether the next recession is imminent. But beyond the obvious fact that there’s another recession out there somewhere, economists’ forecasts can’t help you with the precise timing. Moreover, U.S. consumers are getting a boost from the combination of job growth, nominal wage growth and low inflation thanks to cheap gas. Our calculations suggest that in 2015, these forces combined to boost real labor income by about $240 billion, over 1 percent of GDP; 40 percent of that gain came from lower oil prices. Consumer spending is close to 70 percent of the U.S. economy, so maybe we’re okay for now.

Wherever the next recession is, however, we are definitely not ready for it. Fortunately, we can change that.

Three facts should inform our preparation for the next downturn. First, monetary policy is likely to be constrained. To its credit, the Federal Reserve kept interest rates low as the recovery slowly gained strength, but that means rates probably won’t have much of a perch to fall back from, which limits the potential stimulus from lowering the cost of borrowing.

Second, while the fiscal stimulus in ARRA was far from perfect, it helped to quickly offset the sharp contraction that was the Great Recession. Getting ready for the next downturn means learning lessons from the last one.

Third, as noted, we had a functional federal government the last time we hit a recession. It wasn’t Kumbaya by a long shot, but it was pre-tea party and pre-hyper partisanship. The Recovery Act passed less than four weeks after President Obama took office. Today, we can’t count on Congress to quickly respond.

Put these facts together and you arrive at this conclusion: Policymakers must strengthen the automatic stabilizers in the federal budget.

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Automatic stabilizers are programs that mechanically ramp up during recessions as more people lose income and thus meet the programs’ eligibility criteria. As Catherine Rampell recently noted, SNAP (formerly food stamps) is a good example. When hardship increases during a downturn, more people meet the program’s eligibility requirements, and because SNAP recipients are income-constrained, they inject their benefits into the economy, generating more economic activity than would otherwise occur. In other words, SNAP has a significant “multiplier” effect.

SNAP works well as an automatic stabilizer already, but we can still strengthen that function in it and other programs. For example, in a policy problem that’s getting far too little attention right now, the Unemployment Insurance (UI) system, another key automatic stabilizer, is woefully unprepared for the next downturn. When unemployment spikes up, states finance the increased demand for UI out of trust funds created for precisely this purpose. But fewer than one-third of all states have trust fund balances high enough to pay out a year’s worth of benefits in a recession (a standard criterion for trust-fund readiness). States need to shore up these funds by increasing the taxable wage base that has been unchanged at the federal level for over 30 years.

UI also has an automatic stabilization component — the Extended Benefits (EB) program — that kicks in when specific unemployment rate “triggers” are breached and provides additional weeks of unemployment benefits to workers who have lost their jobs. As the Obama administration recognized in their latest budget, the trigger mechanism in the EB program needs adjusting to be more responsive to need. Adding triggers for some SNAP and Medicaid stimulus could also bolster those programs’ countercyclical properties and improve our readiness for the next recession.

Still, improving our automatic stabilizers won’t obviate the need for Congress to act during deep recessions. At least two additional policy areas would also provide useful stimulus: job creation and housing assistance.

First, during the last recession, a job creation program that temporarily subsidized workers’ wages created hundreds of thousands of jobs with a large bang-for-buck. By creating a relatively small employment fund, Congress could prepare to quickly pull the trigger on direct job creation when the next downturn hits.

Second, the Homelessness Prevention and Rapid Re-Housing Program (HPRP), which significantly held down homelessness in the last downturn, already has an established infrastructure. It can be scaled up in times of need and back down during normal economic times.

There’s an obvious political challenge to the agenda we’re suggesting: We’re worried this Congress won’t act quickly to offset the next recession, so we want them to act now to set up automatic stabilizers that will kick in later without them. We don’t have a solution to that political problem, and as with so much else these days, gridlock may well prevail. But there’s nothing partisan about making sure programs are in place to help those who, by no fault of their own, are hurt by a macroeconomic contraction.

What we do know is that, without beginning to press for these preparatory changes, we can be sure we won’t be ready for the next recession. That, in turn, would ensure a longer, more painful downturn. Yet as the vice president’s comments Wednesday will likely remind us, the ability to avoid unnecessary hardship is well within our reach — if we can only muster the political will to grab it.

Note: This is a summary of a forthcoming paper on this topic, out soon as part of the Center on Budget and Policy Priorities’s Full Employment Project.