Larry Summers, Jeremy Stein, and the Better Off Budget
Larry Summers gave a talk earlier this week at the launch of the Full Employment project headed by Jared Bernstein of the Center on Budget and Policy Priorities (CBPP). In a reasonable, evidence-based world, his talk—and the paper he co-authored with Larry Ball and Brad DeLong for the event—would be deeply influential to policymakers.
The best summation of it is the first paragraph of the accompanying paper:
“At present and going forward, activist fiscal policy is likely to be essential for the American economy to operate near potential levels of output and employment. This conclusion is a substantial change in view from the near-consensus of economists that monetary policy alone could and should be left to carry out the stabilization policy mission, a view that prevailed for nearly a generation prior to the 2008 financial crisis”
Basically, what Summers et al. are saying is that the Federal Reserve won’t be able to engineer a full recovery from the Great Recession (a recovery that remains far from complete) with the monetary policy tools that they have at their disposal. And unless fiscal policy changes sharply from its current contractionary stance to one that supports growth and jobs, the U.S. economy could throw away years of potential income growth (totaling trillions of dollars) and consign millions of workers and families to years of completely needless economic misery.
Besides arguing that the Fed alone couldn’t generate a full recovery with the tools at its disposal, Summers also echoed a point made recently by Jeremy Stein, a member of the Fed’s Board of Governors: that these tools currently being used by the Fed to try to generate recovery—keeping interest rates extraordinarily low for an extended period of time—carry the danger of spurring financial market bubbles that would sow the seeds for the next economic downturn.
Summers was clear that if the choice was between the Fed continuing to wield these tools or doing nothing, he would rather the Fed try to keep boosting the economy. And Stein as well does not argue that the Fed should stop its efforts outright. He simply argues that the possibility that the Fed’s current policy could generate bubbles should be given some weight in its calculations of costs and benefits.
So, because he thinks that monetary policy is likely to be insufficient on its own to generate recovery, and because its attempts to do so could actually carry downsides, Summers makes the obvious logical next step: use another tool of macroeconomic policy—fiscal policy—to return the economy to full-employment. When asked his preferred type of fiscal policy intervention, he identified infrastructure investment.
More importantly, a significant group of actual policymakers also not only agree with this, but have put forward a concrete proposal that reflects Summers’ thinking. The Congressional Progressive Caucus (CPC) recently released its Better Off Budget. A distinguishing feature of this budget is a significant increase in public investment, which is substantially front-loaded to spur a rapid recovery. The CPC budget takes as its goal the closing of the current “output gap” identified by the Congressional Budget Office—this is the gap between actual gross domestic product and GDP that could be produced if demand shortfalls were not keeping resources (mostly unemployed people) from being utilized. The CBO estimates today’s output gap as roughly $800 billion—but it would be much larger (almost double) if the CBO estimates of potential output for 2014 that were made before the Great Recession were still used.
Essentially, CBO has decided that the U.S. has much less potential capacity than it had thought just 7 years ago. But as Summers et al. note, there is very little compelling reason to believe this is so except for the scarring effect of the Great Recession. And the best way to respond to potential output lost to economic slack is to rebuild it through a period of rapid economic growth—and the CPC budget not only provides for this period of rapid growth, it does it through public investments that are likely to be extraordinarily productive given the long period of comparative neglect of key infrastructure.
The U.S. economy remains deeply depressed, even as we approach the 5th year of recovery. Monetary policymakers are trying hard to boost the recovery, but these tools are essentially maxed out. Evidence-based policymakers that actually cared about returning Americans to work would naturally looking at other tools, like reversing fiscal austerity and actually trying to use taxes and spending to spur growth rather than throttle it. And some evidence-based policymakers have done this. They should get more credit for heeding the economic evidence on these issues.