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Although the current economic downturn is not a depression, neither is it a normal recession. Instead, it signals an abrupt transition from the previous state of the world to a very different one. Our economic future depends on how well we understand, and respond to, this momentous shift.
Consider how the operating assumptions of recent decades have been shattered:
These and other trends have converged to produce what is, by many measures, the weakest domestic job market since the Great Depression. The long-term unemployment rate has reached 5.1 percent-almost eight million workers-a post-Depression high. On average, the unemployed have been out of work for nearly 25 weeks, and the percentage of workers who have been unemployed for more than six months has reached its highest level since at least 1948. The average hours of work per employed person has fallen to a record low, and average wage income is on the decline.
In recent weeks, I've talked about these trends with economists of varying political persuasions. At some point in the conversations, most of them utter some variant of, "I just don't see where the growth is going to come from." We may well be facing an extended period of below-trend line growth and above-average unemployment. But one thing is clear: When growth does return, it must be based on a new model-less consumption as a share of GDP, more savings and investment, and a diminished appetite for imports coupled with more production for exports.
There are two critical preconditions for reaching this new equilibrium. The federal government must get its fiscal house in order, otherwise the budget deficit, now projected to average nearly $1 trillion per year over the next decade, will soak up every penny (and then some) of household savings and squeeze private sector investment. And the world's major exporting nations will have to adjust by focusing more on domestic investment and consumption and less on exporting to the United States. The only alternative to a new trade balance is a lower long-term level of global trade, which would leave everyone worse off.
This suggests two urgent tasks in the months ahead. After acting on the 2009 legislative agenda, Congress and the Obama administration must pivot toward long-term fiscal restraint. Unless the president takes the lead early next year by highlighting this challenge in his State of the Union address and submitting a budget that begins to tackle it, it's hard to imagine much progress. And second, returning to global trade negotiations and forging the compromises between developed and developing nations needed to complete the Doha Round, which began nearly eight years ago, must be more than talking points for policy wonks.
These steps are necessities if we are to avoid an outbreak of national beggar-thy-neighbor fiscal and trade policies. We saw that movie in the 1930s, and it ended badly.
COMMENTS (12)
If federal deficits reduce household savings, how can savings surge to 7% of personal income at the same time that deficits are surging?
They aren't inversely related. Household savings are funded by federal deficits. If Obama listens to you and the deficit hawks in Congress, he'll be out of work come Jan 2013.
neweconomicperspectives.blogspot.com/.../The%20National%20Debt
neweconomicperspectives.blogspot.com/.../professor-l-randall ... view full comment
If federal deficits reduce household savings, how can savings surge to 7% of personal income at the same time that deficits are surging?
They aren't inversely related. Household savings are funded by federal deficits. If Obama listens to you and the deficit hawks in Congress, he'll be out of work come Jan 2013.
neweconomicperspectives.blogspot.com/.../The%20National%20Debt
neweconomicperspectives.blogspot.com/.../professor-l-randall-wray-responds-to.html
neweconomicperspectives.blogspot.com/.../twelve-step-program-for-economic.html
Mr. Galston is correct, and most economists do indeed agree with what he says.
Reply to acria multa:
Government deficits can undermine private saving if the deficits lead to inflation, the enemy of saving.
Government deficits, by raising the cost of borrowing, can have the effect of crowding out private investment. That is the phenomenon to which Mr. Galston is referring.
When the economy goes into a recession tax revenues fall and the federal budget goes into deficit. Raising taxes or cutting spending at such a time is clearly not a good idea. But It is a bad idea to run deficits year in and year out, as the Obama administration is proposing. As a rule of thumb the bud ... view full comment
Mr. Galston is correct, and most economists do indeed agree with what he says.
Reply to acria multa:
Government deficits can undermine private saving if the deficits lead to inflation, the enemy of saving.
Government deficits, by raising the cost of borrowing, can have the effect of crowding out private investment. That is the phenomenon to which Mr. Galston is referring.
When the economy goes into a recession tax revenues fall and the federal budget goes into deficit. Raising taxes or cutting spending at such a time is clearly not a good idea. But It is a bad idea to run deficits year in and year out, as the Obama administration is proposing. As a rule of thumb the budget should balance at the peak of every business cycle.
So far as I can tell Mr. Obama's economic advisors agree with what Mr. Galston says in his comment. Unfortunately Congress is beholden to special interests that are unacquainted with economic rationality.
But we should do long-term fiscal restraint AFTER the economy begins to recover, not before.
But we should do long-term fiscal restraint AFTER the economy begins to recover, not before.
Larry Summers said that the fiscal stimulus should be targeted and temporary. But what are the chances of that happening? The money tends to get spent to reward supporters of the administration in power and the constituents of powerful senators and Congress members rather than being targeted for maximum stimulative effect. As for temporary, government programs are rarely terminated. Think of farm subsidies. I read that the subsidy for growing wool for uniforms for soldiers fighting in World War I is still in place.
The best stimulus would be to suspend the payroll tax for a year. That would put more money in the pockets of people working and make it chea ... view full comment
Larry Summers said that the fiscal stimulus should be targeted and temporary. But what are the chances of that happening? The money tends to get spent to reward supporters of the administration in power and the constituents of powerful senators and Congress members rather than being targeted for maximum stimulative effect. As for temporary, government programs are rarely terminated. Think of farm subsidies. I read that the subsidy for growing wool for uniforms for soldiers fighting in World War I is still in place.
The best stimulus would be to suspend the payroll tax for a year. That would put more money in the pockets of people working and make it cheaper for businesses to hire new workers.
Bulbman, I don't think suspending the payroll tax would help as much as you think. There was already a large tax cut as part of the Stimulus Bill, and the evidence suggests that, while some of it was spent, most of the rest was simply added to people's savings. Most of the payroll tax cut would be treated the same way -- if workers are insecure in their jobs and generally suspicious of the health of the economy, they will save most of their tax cuts rather than spending it to get the economy stimulated. Similarly, if there is no increase in spending from consumers, businesses won't hire new workers even if they have extra cash on hand from suspending the payroll tax. ... view full comment
Bulbman, I don't think suspending the payroll tax would help as much as you think. There was already a large tax cut as part of the Stimulus Bill, and the evidence suggests that, while some of it was spent, most of the rest was simply added to people's savings. Most of the payroll tax cut would be treated the same way -- if workers are insecure in their jobs and generally suspicious of the health of the economy, they will save most of their tax cuts rather than spending it to get the economy stimulated. Similarly, if there is no increase in spending from consumers, businesses won't hire new workers even if they have extra cash on hand from suspending the payroll tax. A payroll tax holiday would generate some increased personal consumption and spending around the margins (especially among the working poor, who need to spend most of what they earn), but not nearly enough to re-stimulate the economy into a return to significant growth.
Wildboy writes:
"Most of the payroll tax cut would be treated the same way -- if workers are insecure in their jobs and generally suspicious of the health of the economy, they will save most of their tax cuts rather than spending it to get the economy stimulated."
People feel a need to build up their savings before starting to spend again, and they are right to feel that way. The increased savings resulting from tax cuts, while not directly stimulative, are a prerequisite to an increase in consumer spending down the road.
As for stimulative spending by the government, do you agree with Mr. Summers that it should targeted and temporary and not add to deficits long-term? &n ... view full comment
Wildboy writes:
"Most of the payroll tax cut would be treated the same way -- if workers are insecure in their jobs and generally suspicious of the health of the economy, they will save most of their tax cuts rather than spending it to get the economy stimulated."
People feel a need to build up their savings before starting to spend again, and they are right to feel that way. The increased savings resulting from tax cuts, while not directly stimulative, are a prerequisite to an increase in consumer spending down the road.
As for stimulative spending by the government, do you agree with Mr. Summers that it should targeted and temporary and not add to deficits long-term?
Wow, Bulbman, you sound like Joe McCarthy -- "Are you now or have you ever agreed with Mr. Summers about stimulative government spending?" Sure, I agree with Summers about stimulative spending. And, by that measure, the current Stimulus Bill is pretty good, albeit far from perfect. As for adding to deficits long-term -- that's kind of a non-sequitur, as a one-time shot of stimulus only adds to a deficit "long-term" if there is insufficient revenue in the future to cover it. Again, based on growth projects, there should be plenty of revenue to cover a $787 billion (or even $900 billion) one-time stimulus disbursed over the course of 12 months. ... view full comment
Wow, Bulbman, you sound like Joe McCarthy -- "Are you now or have you ever agreed with Mr. Summers about stimulative government spending?" Sure, I agree with Summers about stimulative spending. And, by that measure, the current Stimulus Bill is pretty good, albeit far from perfect. As for adding to deficits long-term -- that's kind of a non-sequitur, as a one-time shot of stimulus only adds to a deficit "long-term" if there is insufficient revenue in the future to cover it. Again, based on growth projects, there should be plenty of revenue to cover a $787 billion (or even $900 billion) one-time stimulus disbursed over the course of 12 months. What really adds to long-term deficits are quasi-permanent tax cuts that starve the government of revenue for extended periods of time and large, open-ended spending programs whose projected expenditures exceed projected revenues.
As for the benefit of people saving their payroll tax cuts, I don't disagree that this could have an effect of increasing consumer demand down the road. The point is that it doesn't do much to stimulate spending NOW, which leads to a prolonged downturn, more layoffs and less revenue (which leads to even higher budget deficits). Everyone recognizes that, some time down the line, people will have to start spending money again as their cars and appliances begin to wear out, but that day gets prolonged indefinitely if there is insufficient spending today. And you could very well have a situation like in the 1930s, where the baseline of consumer demand permanently declines because saving a lot of money is now seen as a rational economic choice the same way that spending a lot of money was seen as a rational economic choice in fat times.
bulbman:
" But It is a bad idea to run deficits year in and year out, as the Obama administration is proposing"
You do realize that this only because he is using some modicum of honesty in the budgetary process? And that his new initiatives, I believe, account for less than 10% of the forecast deficit, although his continuation of the Bush taxes for those earning below $250k pushes that number high. The US has been running a deficit for a very, very long time, we've just been lying to ourselves about it. Well, the recently thrown-out-of-power party of "fiscal discipline" has.
I absolutely agree that running large deficits in the long term is an extremely ba ... view full comment
bulbman:
" But It is a bad idea to run deficits year in and year out, as the Obama administration is proposing"
You do realize that this only because he is using some modicum of honesty in the budgetary process? And that his new initiatives, I believe, account for less than 10% of the forecast deficit, although his continuation of the Bush taxes for those earning below $250k pushes that number high. The US has been running a deficit for a very, very long time, we've just been lying to ourselves about it. Well, the recently thrown-out-of-power party of "fiscal discipline" has.
I absolutely agree that running large deficits in the long term is an extremely bad idea, but to call this the current administration's idea is rather dishonest. I believe it was our last VP who rather pithily claimed that "Reagan proved that deficits don't matter".
Very fine, well-reasoned article. Unhappily, it appears very unlikely the Obama administration is likely to follow Galston's prescriptions. The Democrats cannot restrain their spending (not to say the Rs were a model of prudence) and they are owned, lock, stock and barrel by organized labor. Andy Stern, Gettlefinger and their compatriots don't wanna know from the Doha round.
Very fine, well-reasoned article. Unhappily, it appears very unlikely the Obama administration is likely to follow Galston's prescriptions. The Democrats cannot restrain their spending (not to say the Rs were a model of prudence) and they are owned, lock, stock and barrel by organized labor. Andy Stern, Gettlefinger and their compatriots don't wanna know from the Doha round.
wow, this has been the most reasoned series of posts by bulbman I have ever read. Very well done sir. wildboy, I got your reservations, but a payroll tax is probably the only additional stimulus that can pass, so on that end alone it is probably worth it.
wow, this has been the most reasoned series of posts by bulbman I have ever read. Very well done sir. wildboy, I got your reservations, but a payroll tax is probably the only additional stimulus that can pass, so on that end alone it is probably worth it.
Bulbman,
I disagree with your understanding but I agree on the solution, payroll tax holiday, only it should not be only one year, it should be as long as it takes to restore full employment. Since we don't have any other projects to fund, and the 1st stimulus has been rather slow to get going and may be too small anyway, little harm can come of adding a payroll tax holiday to it.
I'm aware many economists say they agree with Galston, I'm saying those people are misguided. Please read my links to other economists who see things differently, if you are interested.
Bulbman,
I disagree with your understanding but I agree on the solution, payroll tax holiday, only it should not be only one year, it should be as long as it takes to restore full employment. Since we don't have any other projects to fund, and the 1st stimulus has been rather slow to get going and may be too small anyway, little harm can come of adding a payroll tax holiday to it.
I'm aware many economists say they agree with Galston, I'm saying those people are misguided. Please read my links to other economists who see things differently, if you are interested.
Acria multa, I'm not accusing you of anything. I'm asking whether you agree with Summers' statement about what the stimulus should be. I assume that you do.
You need to be clearer about what your disagreement with Galston is. He's not against a fiscal stimulus. He just agrees with the Chinese, the Europeans and just about everybody except the left wing of the Democratic Party that it is the interest of the US and the world for the US government to get spending under control.
I will read and comment on some of the articles you linked to.
Nari, Reagan's deficits turned out precisely not to be long-term. Reagan's tax cuts and other measures of economic l ... view full comment
Acria multa, I'm not accusing you of anything. I'm asking whether you agree with Summers' statement about what the stimulus should be. I assume that you do.
You need to be clearer about what your disagreement with Galston is. He's not against a fiscal stimulus. He just agrees with the Chinese, the Europeans and just about everybody except the left wing of the Democratic Party that it is the interest of the US and the world for the US government to get spending under control.
I will read and comment on some of the articles you linked to.
Nari, Reagan's deficits turned out precisely not to be long-term. Reagan's tax cuts and other measures of economic liberalization led to economic growth that brought the deficits under control. The problem is that Obama's policies of heavy regulation and high taxes are likely to suppress economic growth, so that we will be unable to grow our way out of the deficits.
Nari writes: "And that his new initiatives, I believe, account for less than 10% of the forecast deficit, although his continuation of the Bush taxes for those earning below $250k pushes that number high." Do you have a citation from the CBO for that claim?
Once the recession is over I think taxes should be raised on people making under $250k. The goal should be a flat income tax rate. The way to get fiscal restraint is for the majority to have to pay for the programs they vote for.
I agree with the criticisms of some of the commentators of the way Bush continued excessive deficit spending after the 2001-2002 downturn was over. But that is hardly an excuse for Obama to commit the same sin ten times over.