After the financial collapse, the U.S. faced the problem of how to stimulate the economy.
The Fed had reduced interest rates to basically zero, and so it was forced to use additional, quasi-experimental tools to keep pumping the economy. And these measures have had limited, and somewhat unpredictable, effects.
Meanwhile, on the fiscal stimulus front, virtually no extra spending was available following the Recovery Act due to politics.
Both of those issues are always going to be there in some way going forward. There's no getting around politics, even in a climate that might be more favorable to spending money.
In a fascinating speech last week at Johns Hopkins (via Matthew Klein), former Obama economic advisor Christy Romer proposes a totally different framework for stimulus.
Essentially we lean on fiscal stimulus more, but we set it up so that it's permanently flexible ... and thus more like monetary policy.
So when the economy goes to crap, payroll taxes automatically drop and other extra benefits automatically rise. And when the economy recovers, payroll taxes begin to rise and other benefits are pulled back. Basically, counter-cyclical fiscal policy is just built into the law.
The most obvious way around the problem caused by the zero lower bound is to use the other main tool in the government’s arsenal to deal with recessions—that is, fiscal policy. If we cannot spur spending and recovery by lowering interest rates, because they are already at zero, we can do it by temporarily lowering taxes and increasing government spending. However, as someone who played a role in crafting the Recovery Act, the fiscal stimulus passed in February 2009, I am acutely aware of how hard it is to get adequate fiscal stimulus through Congress and out into the economy in a timely fashion—even in the midst of a terrible economic crisis.
But fiscal stimulus does work. Study after study has been done on the Recovery Act and the impacts of fiscal stimulus more generally. Though the studies find that some fiscal actions are more effective than others, almost all conclude that tax cuts and spending increases do help spur the economy in the near term. If the fact that normal interest rates are now lower means that we will be hitting the zero lower bound more frequently, we may want to consider ways to use fiscal stimulus faster and more effectively.
You may be surprised to hear that I am a supporter of some form of balanced budget amendment. The fiscal stalemate and irresponsibility in Washington simply has to stop if we are going to remain an economic superpower. But within a framework of fiscal responsibility, such as a balanced budget amendment, it would be possible and, I think, sensible to build in more fiscal fire-fighting power.
We could set up a system that automatically cuts tax rates and increases unemployment benefits and food stamps when the economy weakens. This would get us fiscal stimulus quickly when the economy needs it. To balance out this automatic fiscal expansion, we could require automatic debt reduction in particularly good years. Such a new fiscal policy framework could get us the macroeconomic stability we want, with fiscal responsibility, despite the existence of the zero lower bound.
Romer is far from the first to go in this direction. But her direct perspective of having been in the trenches trying to save the economy while dealing with politics makes her contribution invaluable.
Obviously this would require some major changes in Washington, but as a way of thinking about how to solve the economic problems while being mindful of what's realistic in Washington, Romer is worth listening to.
Read the full speech here.
See Also:Here's What Pepsi, Victoria's Secret, And Other Corporate Logos Would Say If They Were Being HonestTeenagers Are Taking Selfies At Funerals — And A New Tumblr Has The Entire Cringeworthy CollectionUber Will Let You Order A Kitten To Your Office Today