Can You Push on a String? Should You?

It has been a commonplace observation about monetary policy for decades that "you can't push on a string." That is, while monetary policy can definitely slow down an economy during an inflationary period by using higher interest rates, it may no work as well to use low interest rates to stimulate an economy during a period of high unemployment. The problem is that although a central bank can make reserves available to banks, it cannot force banks to want to lend nor households and firms to want to borrow.


However, some would argue that we haven't yet pushed hard enough or long enough. As I will explain, I'm dubious about this argument. But for an example, Charles L. Evans, President and Chief Executive Officer of the Federal Reserve Bank of Chicago, gave a talk on September 7 advocating a more aggressively expansionary monetary policy in "The Fed's Dual Mandate Responsibilities and Challenges Facing U.S. Monetary Policy." Here is some of the flavor of his argument:

"Suppose we faced a very different economic environment: Imagine that inflation was running at 5% against our inflation objective of 2%. Is there a doubt that any central banker worth their salt would be reacting strongly to fight this high inflation rate? No, there isn’t any doubt. They would be acting as if their hair was on fire. We should be similarly energized about improving conditions in the labor market. ...

It is painfully obvious that the large quantities of unused resources in the U.S. are an enormous waste. And it’s not just the current loss—over substantial periods of time, the skills of long-term unemployed workers decline, their re-employment prospects for similar jobs fade, and these reductions in skills have a lasting effect on the future growth potential of the economy. ...

One way to provide more [monetary] accommodation would be to make a simple conditional statement of policy accommodation relative to our dual mandate responsibilities. ... This conditionality could be conveyed by stating that we would hold the federal funds rate at extraordinarily low levels until the unemployment rate falls substantially, say from its current level of 9.1% to 7.5% or even 7%, as long as medium-term inflation stayed below 3%. ... [I]t would not be unreasonable to consider an even lower unemployment threshold that would be enough progress to justify the start of policy tightening. There are other policies that could give clearer communications of our policy conditionality with respect to observable data. For example, I have previously discussed how state-contingent, price-level targeting would work in this regard. Another possibility might be to target the level of nominal GDP, with the goal of bringing it back to the growth trend that existed before the recession."

As I read it, Evans's argument is based on two claims: 1) A truly aggressive monetary policy could bring down the unemployment rate; and 2) The costs of continued high unemployment are enormous, and the risk of significantly higher inflation is low, so uncertainty should be resolved in favor of a more aggressive monetary policy. I am dubious of both these claims. 


Will a more aggressive monetary policy reduce unemployment? 




Evans implies that the Federal Reserve hasn't really done all that much to fight unemployment: he says that if inflation were up, central bankers "would be acting as if their hair were on fire," and says that similar urgency is needed in fighting unemployment.

It seems to me that the Fed has been acting as if its hair was on fire! If you had asked me, circa 1986 or 1996 or 2006, about how I would describe a Federal Reserve which dropped the federal funds rate to near-zero, held it there for three years (since late 2008), and promises to keep it there for another two years (as it did at its August meeting of the Open Market Committee), and at the same time creating money to buy a couple of trillion dollars worth of federal debt and mortgage-backed securities, I would called it an extraordinarily and unimaginably extreme monetary policy. I have supported that extreme reaction, given the extreme circumstances of the U.S. economy in late 2008 and into 2009. But to claim that the Fed hasn't been very aggressive in fighting unemployment is ridiculous.



Milton Friedman once famously said: "Inflation is always and everywhere a monetary phenomenon." At this point, the argument in favor of a more aggressive monetary policy comes close to making the extraordinary claim: "Unemployment is always and everywhere a monetary phenomenon." But is it always possible to fix unemployment with an appropriately strong dose of monetary policy? The answer seems obviously "no." Unemployment is sometimes rooted in structural characteristics of an economy as it slowly adjusts to a severe negative shock.
Evans talks about whether the Fed should move to targeting the price level, or to targetting a level of nominal GDP. Whatever the theoretical arguments for such steps, the Fed's extreme easing has been unable to push up inflation substantially. The central bank certainly seems to have been pushing on a string. And we have the looming example of Japan, where the central bank has been running a near-zero target interest rate for almost 15 years at this point, without successfully stimulating a higher price level. The Fed has already promised to extend the near-zero federal funds interest rate for two years. I just don't believe that promising to keep it there indefinitely, until unemployment falls, is the magic key to stimulating economic recovery.

It doesn't seem pragmatic to say that highly expansionary Fed policies for about four years, since late 2007, haven't worked to reduce unemployment or to create a higher price level, so we must continue those same policies of near-zero interest rates indefinitely. In a previous blog post about a month ago, "Can Bernanke Unwind the Fed's Policies?" , I offered an overview of what the Fed has done and raised some of these issues.


Is there little risk to pursuing an even more aggressive monetary policy?

Sustained high unemployment is a terrible social illness. If it's true that an aggressive monetary policy might help, and at least would be unlikely to harm, then there would be a case for proceeding. But there is at least some chance that harm is being done. Here are three possible risks:

1)What if inflation remains bottled up for some time, but then arrives very quickly over a few months? Or what if the U.S. dollar begins to sink in value very rapidly? After all, we have no real experience with the kind of monetary policy we are conducting. A burst of high and sustained inflation would mean that all the banks and financial institutions which have been holding low-interest debt from the last few years would face huge losses on their portfolios. The Federal Reserve would face such losses on its holdings of debt, too.

2) When the Fed engages in quantitative easing, it is essentially using its power to create money as a way of financing federal government borrowing and mortgage-backed lending. In the middle of the financial crisis in late 2008 and early 2009, this step made sense to me. But if this policy is extended over a period of years, well after the actual financial crisis has ended, surely these trillion-dollar interventions have some possibility of creating lasting distortions in the housing market or in markets for government debt?

3) Perhaps most concerning, the aggressive monetary policy of near-zero interest rates may be locking the economy into slow growth. James Bullard is president and CEO of the Federal Reserve Bank of St. Louis, wrote about this about a year ago in an article called "Seven Faces of `The Peril'".

Bullard argues that there may be two stable equilibria with regard to monetary policy: One equilibrium involves an inflation rate around 2-3% and a nominal interest rate that is slightly higher. This was the situation in the U.S. economy for much of the 2000s, before the financial crisis. The other equilbrium involves an inflation rate of near-zero and nominal interest rates of near-zero. This has been the situation of Japan in the last 15 years or so, and arguably, it is the situation in which the U.S. now finds itself.

Bullard argues that in this situation, the central bank never raises the interest rate, because inflation is low, but it also can't lower the interest rate, because that rate is already near-zero. Thus, the interest rate stops being a tool of monetary policy, and instead is passive and useless. He writes of this situation: "The policymaker is completely committed to interest rate adjustment as the main tool of monetary policy, even long after it ceases to make sense (long after policy becomes passive), creating a second steady state for the economy. Many of the responses described below attempt to remedy the situation by recommending a switch to some other policy when inflation is far below target. The regime switch required must be sharp and credible— policymakers have to commit to the new policy
and the private sector has to believe the policymakers."

Bullard's suggested policy response is to expand quantitative easing by having the Fed purchase additional Treasury securities, but also to get the interest rate back up. He writes:

"The United States is closer to a Japanese-style outcome today than at any time in recent history. In part, this uncomfortably close circumstance is due to the interest rate policy now being pursued by the FOMC [Federal Open Market Committee]. That policy is to keep the current policy rate close to zero, but in addition to promise to maintain the near-zero interest rate policy for an “extended period.” But it is even more than that: The reaction to a negative shock in the current environment is to extend the extended period even further, delaying the day of normalization of the policy rate farther into the future.
Promising to remain at zero for a long time is a double-edged sword. ... Under current policy in the United States, the reaction to a negative shock is perceived to be a promise to stay low for longer, which may be counterproductive because it may encourage a permanent, low nominal interest rate outcome. A better policy response to a negative shock is to expand the quantitative easing program through the purchase of Treasury securities."

 I haven't figured out whether I believe the Bullard-style model. In the U.S., we don't have enough experience with a near-zero federal funds interest rate to be highly confident about what will happen. But it is at least possible that those who advocate extending near-zero interest rates are doing more to trap the U.S. economy in Japan-style stagnation than to stimulate a robust recovery.

Is the Great Depression is the Right Analogy for the Great Recession?

Barry Eichengreen delivered the Presidential Address to the Economic History Association,

"Economic History and Economic Policy," which is available at his website. He begins (footnotes omitted):

"This has been a good crisis for economic history. It will not surprise most members of this audience to learn that there was a sharp spike in references in the press to the term "Great Depression" following the failure of Lehman Bros. in September of 2008. More interesting is that there was also a surge in references to "economic history," first in February of 2008, with growing awareness that this could be the worst recession since you know when, and again in October, coincident with fears that the financial system was on the verge of collapse. Journalists, market participants, and policy makers all turned to history for guidance on how to react to this skein of otherwise unfathomable events."

Eichengreen discusses with care and detail whether analogies are chosen because they are the best example, or because they are a salient example almost within living memory, or because they deliver an already-selected policy conclusion. Drawing on a wide variety of political and economic examples, Eichengreen points out that since historical episodes never precisely match present events, often the most productive way to use history in making economic policy is not to use a single analogy, but instead to consider a number of somewhat relevant episodes, and to compare and contrast the events, policies, and outcomes.   He makes the provocative point that the choice of analogy has a tendency to guide policy responses. In the case of the analogy from the Great Depression to the Great Recession:

"The analogy legitimated certain responses to the collapse of economic and financial activity while delegitimating others. It legitimized the notion that the Fed should respond aggressively to prevent the collapse of a few investment funds from precipitating a cascade of financial failures. This reflected the widespread currency of Friedman and Schwartz‘s interpretation of the Great Depression – that what had made the Depression great was the inadequate response of the Federal Reserve. ... The analogy with the Great Depression informed the policy response to the crisis more generally. The Federal Deposit Insurance Corporation increased deposit insurance coverage to $250,000 per depositor exactly one day after press references to the Great Depression peaked. The action was presumably informed by the view of the banking panics of the Great Depression as runs by uninsured depositors, and the historical interpretation, widely shared, that those panics had played a key role in the contraction of the money supply and the impairment of the payments system. The analogy with the Great Depression similarly lent legitimacy to the argument that the Congress and Administration should respond with fiscal stimulus. This reflected the "lesson" of history that the depth and duration of the Depression were attributable in no small part to the fact that fiscal stimulus was not used to counter the collapse of private demand. ...

The analogy with the Great Depression also delegitimized the temptation to respond with protectionist measures designed to bottle up the remaining demand. This reflected the lesson, widely taught to undergraduates and invoked by policy makers, that the Smoot-Hawley Tariff aggravated the crisis of the 1930s. In fact, this "lesson" of history is not supported by modern research, which concludes that Smoot Hawley played at most a minor role in the propagation of the Depression."

Eichengreen points out that these policy lessons are not the only possible lessons from the Great Depression, and that choosing other historical episodes might have emphasized other lessons. 

"Did we need a new Neal Deal? Well, that depended on whether you sided with historians who argue that the New Deal helped to end the Depression or only prolonged it. Did we need a jolt to the exchange rate to vanquish deflationary expectations? The answer depended on whether your view was that Roosevelt‘s decision to take the U.S. off the gold standard in 1933 was the critical decision that transformed expectations and ended deflation or whether you thought it was a sideshow. For those attempting to move from metaphor to analogy, this was a reminder that the distilled, authoritative incapsulation of the period remains a work in progress.
Although the Great Depression was clearly the dominant base case in discussions of the 2008-9 crisis, there were other possible analogies. There was the 1873 crisis, driven by an investment boom and bust like that of the period leading up to 2007, which led to the failure of brokerage houses, in parallel with the problems in 2008 of the investment banks. There was the 1907 crisis, in response to which J.P. Morgan organized a lifeboat operation that resembled in important respects the 2008 rescue of Bear Stearns by none other than JP Morgan & Co."

Eichengreen also makes the point that the connection from past to present also works in reverse: for example, current economic events will alter our historical understanding of the policy reactions to the Great Depression.

"The mainstream narrative is that the experience of the Depression led to a series of institutional and policy innovations making it less likely that something similar thing would happen again. American economic historians refer in this connection to federal deposit insurance, unemployment insurance, Social Security, the Securities and Exchange Commission, the concentration of monetary-policy-making authority at the Federal Reserve Board, and automatic fiscal stabilizers. Historians of other countries have similar list. Although the stabilizing impact of particular entries on these lists has been disputed, the thrust of the dominant narrative is clear.

We now have had a graphic reminder that we have less than fully succeeded in corralling threats to economic and financial instability. While policy responses may avoid the repetition of past threats, they are no guarantee against future threats. Markets tend to adapt to stabilizing policy innovations in ways that render those innovations less stabilizing. As memories of the earlier crisis fade, policy makers themselves become more likely to consort with market participants in this effort. I suspect that we will now see more attention to these longer-term adaptations to the legacy of the Great Depression and less to the short-term policy response."

U.S. Poverty by the Numbers

Each September the U.S. Census Bureau releases an annual report on the U.S. poverty rate. Each year, the report is grist for the media mill for a few days, with arguments that the official poverty rate overstates or understates "true" poverty. But at least in the days right after the poverty numbers come out, I prefer not to perform in this annual dance of the definitions. Here, I'll make four more basic points, with minimal editorializing: 1) Show the 2010 poverty thresholds and trends over recent decades; 2) Show how poverty has come to affects the young more than other age groups; 3) Show the drop in median household income not just since the start of the recession in 2007, but back to 1999; and 4) Preview an argument about definitions of poverty that is coming next month. 

1) The 2010 poverty thresholds and trends over recent decades

The poverty rate is based on money income. As the report explains: " If a family’s total money income is less than the applicable threshold, then that family and every individual in it are considered in poverty. The official poverty thresholds are updated annually for inflation using the Consumer Price Index (CPI-U). The official poverty definition uses money income before taxes and tax credits and excludes capital gains and noncash benefits (such as Supplemental Nutrition Assistance Program benefits and housing assistance). The thresholds do not vary geographically." The poverty thresholds are adjusted for household size and for number of children in the household. Here they are for 2010:

As an economist, I lack any talent for drama. But I do sometimes try to give a little life to the poverty thresholds by pointing out that the poverty line for a three-person household with two children is $17,568. Divide that by 365 days in a year, and by three people per meal. It's about $16 in total consumption per person per day. There are high-end restaurants in most U.S. cities where $16 will buy you a fancy appetizer. The share of the population below this poverty line--the "poverty rate"-- dipped in the 1960s, but since the 1970s has hovered between about 12-15% of the population.

2) How poverty has come to affects the young more than other age groups

In the early 1960s, poverty was more prevalent among the elderly. But in the early 1970s, the poverty rate for the elderly dropped below that for those in the under-18 age group. From the mid 1980s up to about 2000, poverty rates for the elderly were similar to those for the age 18-64 population. Since about 2001, poverty rates for the elderly have been below those for the 18-64 age group. Currently, the poverty rate for those over 65 is 9.3%; for the 18-64 age group, 13.7%; for those under 18, 22%. As we discuss the problems of our aging society and how we have set up Social Security and Medicare systems whose current financing will not be able to deliver the promised benefits, it's worth remembering that more than a fifth of those under age 18 are living in households below the poverty line.

In fact, the closer you go to the poverty line, and below the poverty line, the more the under-18 population is overrepresented. Specifically, those under age 18 are 24.4% of the total population;  31.3% of the population with income below 200% of the poverty threshold; and 35.5% of the population below 100% of the poverty threshold.

3) Median household income has dropped not just since the start of the recession in 2007, but compared to 1999

The median household is the household where half of all households have more money income and half have less: that is, the household at the 50th percentile of the income distribution. Income gains for those at the top of the income distribution affect average income, but they do not affect median income. The report points out:  "Real median household income was $49,445 in 2010, a 2.3 percent decline from 2009 ... Since 2007, median household income has declined 6.4 percent (from $52,823) and is 7.1 percent below the median household income peak ($53,252) that occurred in 1999 ..." Here's the figure:

4) A Preview of a Coming Debate over the Supplemental Poverty Measure

The Census Bureau is of course perfectly aware of the disputes over how poverty should be measured, and has long offered alternative measures of poverty for those who took the time to read the fine print. Back in 1995, there was a big National Academy of Sciences report on ways of measuring poverty. In October, the Census Bureau is planning to come out with a measure of poverty that is more closely linked to actual consumption:


"The official poverty measure, which has been in use since the 1960s, estimates poverty rates by looking at a family’s or an individual’s cash income. The Supplemental Poverty Measure will be a more complex statistic, incorporating additional items such as tax payments and work expenses in its family resource estimates. Thresholds used in the new measure will be derived from Consumer Expenditure Survey expenditure data on basic necessities (food, shelter, clothing, and utilities) and will be adjusted for geographic differences in the cost of housing. The new thresholds are not intended to assess eligibility for government programs. Instead, the new measure will serve as an additional indicator of economic well-being and will provide a deeper understanding of economic conditions and policy effects."

Africa's Growing Middle Class (!?!)

It's easy to compile a list of reports dating back several decades about how the economies of sub-Saharan Africa are really truly about to take off and grow this time. But over the last 10 years or so, there is some evidence that the predictions may at last be coming true. I posted a few months back about the modest but real increases in foreign direct investment to Africa and exports from Africa in recent years. Last May, the African Development Bank put out a report in May called "The Middle of the Pyramid: Dynamics of the Middle Class in Africa."

In developing economies, the "middle class" is usually take to run from $2/day to $20/day in consumption per person. By that standard, here's what Africa's distribution of income looked like in 2010:

The African Development Bank reports: "Recent estimates put the size of the middle class in the region in the neighborhood of 300 to 500 million people, representing the population that is between Africa's vast poor and the continent's few elite. Africa’s emerging middle class comprises roughly the size of the middle class in India or China."

The increase in the middle class has been substantial in the last few decades.  The middle class was 26.2% of the population in 1980, 27% in 1990, 27.2% in 2000--and then 34.3% in 2010. To be sure, a lot of this growth was in the lowest level of the middle class, those consuming $2-$4/day on a per person basis. If one looks only at the middle class from $4-$20/day, their share of the population actually declines a bit from 1980 to 2010. The progress here is obviously slow, but nonetheless seems real.

The middle class is important for a number of reasons. It creates a local market that didn't exist before for many goods and services, and can have a positive effect on governance. The ADB reports: 

"Strong economic growth in the past two decades has helped reduce poverty in Africa and increased the size of the middle class. Although the growth in Africa’s middle class has not been very robust, it has nonetheless been noticeable and contributed to increased domestic consumption in many African countries, a development that could help to foster private sector growth in African countries. Sales of refrigerators, television sets, mobile phones, motors and automobiles have surged in virtually every country in recent years. Possession of cars and motor cycles in Ghana, for example, has increased by 81% since 2006. As such, the middle class is helping to foster private sector growth in Africa as they offer a key source of effective demand for goods and services supplied by private sector entities.

The middle class is also helping to improve accountability in public services through more vocal demands for better services. The middle class is better educated, better informed and has greater awareness of human rights. It is the main source of the leadership and activism that create and operate many of the nongovernmental organizations that push for greater accountability and better governance in public affairs, a position that augurs well for creating a suitable environment for growth and development."

And here's one other statistic that jumped out at me: "The number of internet users [in Africa], which can be used as a proxy for middle class lifestyles, has increased from about 4.5 million people in 2000 to 80.6 million people in 2008." 

The U.S. Loses its Dominance in Initial Public Offerings

The United States used to dominate the market for provision of initial public offerings, but no longer. 
Craig Doidge, G. Andrew Karolyi, and René M. Stulz document the patterns in a March 2011 paper "The U.S. Left Behind: The Rise of IPO Activity Around the World." It can be downloaded at SSRN, or for those with access to NBER working papers, it is available as #16916.
 
Initial public offerings matter for at least two reasons. In a direct sense, they are an important way in which successful entrepreneurial companies have access to financing for expansion. In an indirect sense, IPOs tend to go where the financial and legal institutions are favorable. Thus, a drop-off in IPOs is bad news for entrepreneurs, and also acts as a sort of canary in the coal mine, telling you that the institutional environment for raising capital in this way isn't favorable. Here is their overview:

"We build a comprehensive sample of 29,361 IPOs from 89 countries constituting almost $2.6
trillion (constant 2007 U.S. dollars) of capital raised over 1990 to 2007. Although the worldwide share of IPO activity by U.S. firms still ranks near the top, during the 2000s, U.S. IPOs have not kept up with the economic importance of the U.S. In the 1990s, the yearly average of the number of U.S. IPOs comprised 27% of all IPOs in the world while the U.S. accounted for 27% of world Gross Domestic Product (GDP). Since 2000, the U.S. share of all IPOs has fallen to 12% whereas its share of worldwide GDP has averaged 30%. The average size of a typical IPO in the U.S. is larger than that in the rest of the world so that IPO proceeds may be a more relevant metric. Yet, in the last five years of our sample, IPO proceeds raised by U.S. firms drop to 16.2% of world IPO proceeds, despite the fact that the stock market capitalization of the U.S. relative to that of the world averages 41% during this period."

The first figure that follows shows counts of the total number of IPOs: the red line showing the world total, and the other lines showing those occurring in the U.S., the UK, and China. The second figure shows proceeds from IPOs, measured in millions of dollars. The third figure shows the declining U.S. share of the IPO market over time as measured by the number of IPOs done.

Charles Ponzi and Social Security

 In January 2009, Larry DeWitt of the Social Security Administration Historian's Office wrote a "Research Note" called "Ponzi Schemes vs. Social Security."  DeWitt includes a nice short history of what Charles Ponzi actually did.

"Charles Ponzi was a Boston investor broker who in the early months of 1920 was momentarily famous as a purveyor of foreign postal coupons who promised fabulous rates of return for his investors. Ponzi issued bonds which offered 50% interest in 45 days, or a 100% profit if held for 90 days....

Ponzi opened his company, "The Securities Exchange Company," at 27 School Street in Boston the day after Christmas 1919. He was penniless at the time and had to borrow $200 from a furniture dealer in order to furnish his new office. Within days he was collecting money from his initial rounds of investors. He then expanded the circle of investors by collecting money from a larger round of investors. When the bonds of the first investors came due he paid them, with their miraculous profit, using the money collected from the second round of investors. The news of these extraordinary profits swept up and down the east coast and thousands of investors flocked to Ponzi's office for an opportunity to give him their money. Using the money from this new surge of investors he paid off the next round of bonds as they came due, with their full profit, which excited even more frenzy. ...

Ponzi started his scheme on December 26th. Precisely seven months later, on July 26th, at the insistence of the Massachusetts District Attorney, Ponzi quit accepting deposits from new investors. It was estimated that Ponzi had been taking in $200,000 a day of new investments prior to the halt. At that point he had already collected almost $10,000,000 from about 10,000 investors. As word got out about his legal troubles, worried investors swarmed his office. Ponzi confidently greeted them and assured them all was well. ...

From July 26th until he was jailed on August 13th, Ponzi kept up this practice, appearing at the office each day and redeeming bonds from worried investors. During this time he actually redeemed $5,000,000 of his bonds in a futile attempt to convince the authorities that he was on the up and up. At his bankruptcy trial, it was discovered that Ponzi still had bonds outstanding in the amount of $7,000,000 and total assets of about $2,000,000. Indeed, the seemingly lucky investors who redeemed their bonds after July 26th had to return their windfalls to the bankruptcy court to be distributed among Ponzi's larger circle of creditors. Ultimately, after about seven years of litigation, Ponzi's disillusioned investors got back 37 cents on the dollar of their principal, with, of course, no whiff of any profits from the nation's first and most notorious Ponzi scheme."

How does Ponzi's arrangement differ from the Social Security system? As DeWitt points out, the U.S. Social Security system is a transfer program between generations, from those in working age to those in retirement, not a pyramid scheme that relies on attracting continually increasing numbers of "investors" to pay off those who invested earlier. DeWitt writes: 

"If the demographics of the population were stable, then a pay-as-you-go [Social Security] system would not have demographically-driven financing ups and downs and no thoughtful person would be tempted to compare it to a Ponzi arrangement. However, since population demographics tend to rise and fall, the balance in pay-as-you-go systems tends to rise and fall as well. During periods when more new participants are entering the system than are receiving benefits there tends to be a surplus in funding (as in the early years of Social Security). During periods when beneficiaries are growing faster than new entrants (as will happen when the baby boomers retire), there tends to be a deficit. This vulnerability to demographic ups and downs is one of the problems with pay-as-you-go financing. But this problem has nothing to do with Ponzi schemes, or any other fraudulent form of financing, it is simply the nature of pay-as-you-go systems....The first modern social insurance program began in Germany in 1889 and has been in continuous operation for more than 100 years. The American Social Security system has been in continuous successful operation since 1935. Charles Ponzi's scheme lasted barely 200 days."

Thanks to David Henderson at EconLog for the pointer.

If Only the Government Could Wave a Magic Wand and Create Jobs

I've written a "Commentary" for Minnesota Public Radio's news site, "If only the government could wave a wand and create jobs." You can check it out at the MPR website, with an actual photo of me, or just read it here:

"If only the government could wave a wand and create jobs"

by Timothy Taylor

September 15, 2011

Back in 1993 there was a movie called "Dave," which I went to see because it starred Kevin Kline. But for an economist, the ending of the movie was physically painful, because I was rolling my eyes so hard.

In "Dave," an everyday person who looks like the president of the United States ends up through a comic chain of implausibilities actually becoming president. The big end-of-movie wind-up for Kevin Kline's "Dave" character, acting as the wise and beloved president, is passing a law to eliminate unemployment by having the government guarantee a job for everyone.

You don't have to be an economist to suspect that solving unemployment isn't this simple. Really? The only reason the United States has unemployment is that we haven't passed a law guaranteeing jobs for all? And this great idea of eliminating unemployment by guaranteeing jobs for all hasn't occurred to Germany or Sweden or Japan or any other country?

Off the movie screen, incentives and tradeoffs can't be ignored. If the government is going to guarantee jobs with wages, it needs to pay for it with taxes, which affects incentives for those who pay current taxes, or with borrowed money, which tends to crowd out private-sector borrowers in the present and also affects the workers who will need to pay taxes to repay that borrowing in the future. Moreover, if you "guarantee" a job, what will be the pay and benefits? Is the job permanent? Does the government also pay for transportation and child care? Can the government require that you move to another place to take the job? What's the motivation to do the guaranteed job if you can't be fired? How will firms react when their current and potential employees can take these government jobs? How do we draw the line between helping those who would be unemployed and turning on a government spending spigot that will be hard to shut off?

Eighteen years after "Dave," I still roll my eyes when people talk as if the government can cure unemployment by passing a law. However, when an economy is sunk in recession, government can help to ease the pain with a combination of temporary spending increases and tax cuts. Thus, although I have I have my quarrels with how the various laws were designed and targeted, I overall supported both the Bush economic stimulus package in 2008 and the Obama stimulus in 2009.

I was predisposed to support at least some of President Obama's most recent labor proposals as well, with the unemployment rate still above 9 percent, but the proposals don't seem politically serious. When Obama gave his speech last Thursday, exhorting Congress to pass his bill without delay, he had not yet sent Congress a bill.

Then, when the bill arrived early this week, it no longer proposed having the bipartisan deficit commission take the jobs plan into account in its plans to address the deficit in the middle term — as Obama had proposed in the Thursday speech — but instead called for limiting deductions for those with high incomes. I favor raising the tax burden on those with higher incomes as part of an overall medium-term deficit-reduction package. But raising that issue now works against gaining support for an immediate bill to help some of the unemployed.

Ultimately, all of these bills are temporary palliatives--aspirin to dull the pain of a feverish economy. Government-supported jobs and stimulus packages are worthwhile when the unemployment rate is stuck above 9 percent, but they aren't a long-run path to lower unemployment. The economy needs hiring by private firms.

A pro-jobs agenda for the long run is a tougher task than waving a "Dave"-type magic wand. Some useful steps might include the following:
 
Build a national program of apprenticeships to connect high school students with real-world job skills and possible future employers, as has been done in Germany.

Redesign unemployment and disability rules to encourage employment while still protecting the needy, as has been done in the Netherlands and Denmark.

Overhaul and retarget the 45 or so federal job training programs that already exist. Provide greater support for job search and for moving to take a job.

Other steps would focus on the broad climate for business:
 
Reform the corporate tax code to close loopholes, reduce tax rates and encourage investment.

Make sure that firms are following rules about environmental protection, financial disclosure and safety of workers and consumers, but then get out of the way and let them function.

Take concrete steps to put federal government finances on a sustainable path over the next five to 10 years.

For most of the second half of the 20th century, the U.S. economy could assume, through better and worse years, that many firms would do most of their production within America's boundaries. But in the globalizing economy of the 21st century, firms have more choices. The United States needs to rethink and redesign its economic institutions to make itself a more attractive location when firms are deciding where to produce and hire.
----
Timothy Taylor is managing editor of the Journal of Economic Perspectives, based at Macalester College in St. Paul. He blogs at conversableeconomist.blogspot.com.