Cheers for the Recovery Act on its 5th Birthday, Jeers for the Anti-Recovery Act We’ve (Implicitly) Passed in the Past Three Years
Today marks the fifth anniversary of the signing of the American Recovery and Reinvestment Act (ARRA, or simply the Recovery Act). Passed after a six-month stretch during which the economy lost an average of 750,000 jobs each month, ARRA was the single biggest contributor to stopping the economic freefall that followed the bursting of the housing bubble. To be clear, the assessment that the ARRA contributed significantly to ending the Great Recession is not a contested opinion among macroeconomists, or at least not among those macroeconomists whose paycheck depends on correctly predicting what will impact economic activity. (For example, figure C in this briefing paper shows a set of estimates from both private and public macroeconomic forecasters of ARRA’s impact on gross domestic product during its peak quarter of effectiveness.)
Further, ARRA’s overall impact was significantly blunted by the fact that a significant portion of its overall cost was absorbed by tax cuts for business and higher-income households (see tables 1 and 2 in this White House factsheet, for example)—a significantly less effective form of stimulus than either direct government spending or safety net programs. Research since ARRA has confirmed that the effective parts of ARRA—aid to state and local governments to finance Medicaid payments or build infrastructure projects—provided even better stimulus than ex ante estimates indicated.
Why is it important to remember this history? Because in a reasonable policymaking environment we would be trying to enact more fiscal stimulus today, to complete the road to full recovery from the Great Recession.
It’s instructive to recall that ARRA was the second fiscal stimulus package passed to neutralize the demand shock inflicted by the burst housing bubble. The first one, the Economic Stimulus Act (ESA) of 2008, was passed because (a) people were worried that the Fed was running out of ammunition to fight an oncoming recession, as they had already lowered short-term policy rates to just below 3 percent, and (b) it was forecast that unemployment could rise as high as (gasp) 6.5 percent.
Today, of course, the Fed’s short-term policy interest rates have been buried at zero (their lowest plausible value) for more than five years. Unemployment, meanwhile, sits at 6.6 percent—and even this is unnaturally depressed because of the nearly 6 million workers who have stopped activity searching for work because job opportunities remain so depressed. The reason for this depressed economy remains a severe shortfall of aggregate demand relative to productive capacity—a gap that is at least $500 billion and could well be as high as $1 trillion, and which is much larger than the gap that characterized the economy when the ESA was passed.
Strangely, what was a wide consensus among policymakers in 2008 and 2009—that fiscal policy should be used to push the economy back to full recovery—is now essentially a political orphan (a notable exception to this is the Congressional Progressive Caucus’ Back to Work Budget from last year). But the underlying economics of why we need the equivalent of another ARRA to get the economy fully back to recovery are pretty straightforward: we’ve essentially passed the equivalent of anti-Recovery Acts in each of the past three years. The figure below shows public spending in the most recent recovery relative to other recoveries. After the initial burst of spending provided by the Recovery Act in 2009 and 2010, spending has lagged further and further behind its performance in all other post-war recoveries. By 2013, the gap between public spending that actually prevailed in that year and what would have prevailed had it just matched the average trajectory of previous recoveries was larger than the peak years of spending in the Recovery Act.
To put this simply, the economic significance of the austerity imposed in recent years dwarfs the size of the stimulus provided by the Recovery Act. No wonder the economy still needs more fiscal stimulus to get back to full recovery.
There are at least some small reasons for optimism on this front going forward. First, the fiscal drag for 2014 is set to be much less than 2013—even before the recent Ryan-Murray deal which even further loosened the grip of austerity. Second, there has been some recent rumbling about the desirability of making infrastructure investments to boost recovery, including calls for this even from some Republican economists. Lastly, the root of federal austerity in recent years is the Budget Control Act (BCA) of 2011, which gave us large discretionary spending cuts (including, but not limited to, the now infamous “sequester”). The BCA was the outcome of Republicans in the House of Representatives demanding spending cuts in exchange for what has historically been a routine, pro forma vote to raise the statutory debt ceiling. Just this past week, the political dynamic where the House GOP caucus could demand policy concessions as the price of raising the debt ceiling finally seems to have broken.
A final bit of irony is that another Recovery Act passed today would actually lead to much faster, tangible economic improvement than the original one did. 2009’s Recovery Act halted a downward spiral, to be sure, but didn’t lead to an economy producing hundreds of thousands of jobs each month (and, in fact, a large share of the full-time equivalent jobs created by ARRA were actually probably absorbed by rising average hours rather than new employees on payrolls—still useful, but not something that led to impressive monthly job numbers). Large fiscal stimulus passed today would quickly lead to levels of job-growth last seen during the labor market boom of the late 1990s. Political reality argues this won’t happen soon, so in the meantime we should give three cheers for the Recovery Act we actually had. The economy is much better off for it.