Economic Analysis In Support Of Economic Recovery
Economic Analysis in Support of Economic Recovery & Reinvestment Act
The proposed $550 billion package of well-targeted government spending makes sense
today because
the economy and jobs are sinking fast and need a big boost;
we have a large backlog of worthwhile infrastructure projects that have been
studied and approved;
states are on the verge of sharply reducing investments in education, health, and
public safety;
investments in technology and skills will pay dividends for many years; and
as millions of additional families face severe economic hardship, we should take
forceful action to support employment and to provide income support for those
who lose their jobs and income.
This package should have the effect of staving off the worst prospects of the current
economy now in the process of “shutting down” in the words of a recent congressional
economic witness. But there remains a significant likelihood that further action will be
needed. There is a very real risk that, because of unanticipated economic bad news,
this legislation may undershoot its target. Congress must be alert to counter additional
economic weakness because the strength of the country and security of American
families are at stake.
Lack of Demand Creates Extraordinary Slack
The federal government should step in to increase demand for American goods and
services because all other sources of demand are declining.
• Households are spending less because they're losing jobs and their homes and
investments are losing value. In the second half of 2008, real consumer
spending on goods plunged at the fastest rate in six decades of data.
• Businesses are scaling back investment because they have more and more
excess capacity and they lack confidence that demand for their goods and
services will recover soon enough to justify adding more capacity.
• State and local governments are retrenching because of falling revenues and
balanced budget requirements. The Center on Budget and Policy Priorities
estimates that the states' fiscal gap will reach 17 percent of their general budget
in the next fiscal year and that they face a combined $350 billion shortfall for the
remaining six months of this fiscal year and the next two fiscal years.
• Recessions abroad are shrinking demand for our exports. The consensus of
economic forecasters calls for GDP to shrink this year in Europe and Japan by
the same 1-1/2 percent as in the United States.
The recession has already created considerable economic slack and forecasters expect
that slack to increase. Improving technology and rising population together raise the
economy’s potential output by at least 3 percent a year. Actual output today is lower
than it was five quarters ago. That 3 percent shortfall means that we are already
producing about $500 billion below our potential. Although they are factoring in positive
effects from stimulus legislation, economic forecasters expect that shortfall to double
over the next year and to remain large for an extended period after that.
We will need a strong fiscal boost to continue even after the economy hits bottom and
starts to grow again, possibly later this year or early next year. The usual drivers of
strong recoveries – housing and autos – seem unlikely to provide the typical boost this
time around. Even after output hits bottom, employers seem likely to hold off hiring, just
as they did in the years just after the last two recessions. Unemployment rose another
1.5 million in the 15 months after the 1990-91 recession and by 1.3 million in the 19
months after the 2001 recession. Because of the continued overhang of vacant
housing, economic forecasters expect to see subpar growth throughout 2010 and thus
unemployment to exceed 8 percent -- higher than at any time in the last quarter century.
Unfortunately, the current trajectory of the economy allows ample capacity to absorb the
3.7 million jobs that the Obama economic team projects will be created or saved by the
recovery bill. That’s less than the 4.3 million rise in unemployment that has occurred
from 6.8 million in mid 2007 to 11.1 million in December 2008. The consensus of
economic forecasters expects unemployment to reach 13 million people in 2010, even
after they factor in sizable economic stimulus. Forecaster Zandi projects that, without
stimulus, we would see unemployment reach 16 million people in 2010.
The rate of deterioration in the job market has been accelerating. The January 9 labor
report came in worse than had been expected at the time of the projections made in the
last paragraph, not only for December but for prior months. Over the last three months
of 2008, both job loss and unemployment increases have been running about 500,000 a
month, for an annual rate of 6 million.
The current downturn has also seen an unprecedented level and increase in the
number of people who have been involuntarily cut back from full-time to part-time work
by their employer. That number has doubled from less than 2.9 million in the summer of
2007 to 5.9 million in December 2008. 4.2% percent of those still employed – one in
every 24 – have held on to their job but have only part time hours instead of the full time
hours that they had and want. The combination of rapidly falling employment and
massive shift from full time to part time work resulted in the steepest decline in hours
worked since 1974.
Positive Effects from the Recovery Bill
Two recent economic studies reached similar conclusions with respect to the benefits of
an economic stimulus bill along the lines of this one. They both find that such a bill
would slow the inexorable economic decline over the next year and bring a stronger
recovery sooner. Neither study expects unemployment to decline back to the levels of a
few months ago any time soon.
A January 10 analysis done by Christina Romer (President-elect Obama’s nominee to
chair the Council of Economic Advisers) and Jared Bernstein (economic adviser to Vice
President-elect Biden) estimated that, by the end of 2010, the package would:
lower the unemployment rate by 1.8 percentage points and
save or create 3.7 million jobs
relative to what would occur without a stimulus package.
A January 6 analysis by Mark Zandi of Moody's Economy.com (and prominent
economic advisor to the presidential campaign of Senator McCain in 2008) found that a
$750 billion stimulus package:
would lower the unemployment rate by 2 percentage points in mid 2010 relative
to the rate without the stimulus; and
lead to 3.8 million more payroll jobs in 2010 and, even more striking, 17 million
more job-years over the next four years.
Although the two studies find that the recovery package would have comparable effects,
Zandi starts with a much more pessimistic base line. While he finds that the package
would lower unemployment from 11 percent to a bit less than 9 percent in late 2010,
Romer-Bernstein say it would lower unemployment from a base case of 8.8 percent to
7.0 percent. Both studies could correctly estimate the effects of the proposed recovery
package but, if the pessimistic Zandi baseline is correct, the actual path of
unemployment could resemble what the Obama team is projecting if nothing is done.
Lessons from the Great Depression
The Great Depression of the 1930s taught some hard lessons. After the financial
bubble burst in 1929, both fiscal and monetary policy turned restrictive. Over the next
four years, real per capita income dropped by a third and unemployment soared from
3.2 percent to 22.5 percent. The aggressive spending, regulatory and monetary
reforms of the New Deal revived the economy: unemployment dropped to 9.1 percent
by 1937 and GDP per capita had fully recovered its 1929 level. In 1937 policy makers
mistakenly decided that they needed to eliminate the deficit of 2.2 percent of GDP.
Slashing New Deal jobs programs and raising taxes did succeed in lowering the deficit
to 0.1 percent of GDP, but it also threw the economy into a recession. Unemployment
jumped back up to 12.5 percent by 1938 and manufacturing production plunged 24
percent. Both the successes of 1933-37 and the failure of 1937-38 should inform our
policy-making in this economic downturn.
Infrastructure and Construction Issues
A large boost to federal infrastructure spending makes sense for several reasons:
1. Infrastructure projects – transportation, scientific facilities, improved energy
efficiency – make the economy more productive and reduce oil imports and
greenhouse gas emissions while raising the quality of life.
2. State and local governments are scaling back needed infrastructure projects
because of budget pressures.
3. Construction workers have by far the highest unemployment rate of any industry.
Construction has been the hardest hit industry and occupation in this recession. In just
the last year, construction employment has plummeted by 1.3 million workers, from 9.3
million to 8.0 million while unemployment among construction workers far exceeds that
in any other occupation.
The rapid deterioration in construction and manufacturing has caused unemployment to
rise much faster among men than among women. In the summer of 2007, men and
women had comparable unemployment rates (4.7 percent versus 4.6 percent,
respectively). By the end of 2008, however, unemployment among women rose to 6.4
percent as it soared to 7.9 percent among men. The 1.5 percent gap between men's
and women's unemployment is the largest margin that men's unemployment has
exceeded women's on record. (Unemployment rates for men and women have closely
tracked each other for most of the last 30 years, but before that women's unemployment
usually exceeded men's, often by large margins.)
According to the previously cited study by Christina Romer and Jared Bernstein for the
Obama transition, “women have accounted for roughly 20% of the decline in payroll
employment,” but “the total number of created jobs likely to go to women is roughly 42%
of the jobs created by the package.” They found that, while infrastructure spending will
favor men who predominate in construction, other parts of the package boost jobs in
industries that favor women. For example, fiscal relief to states will support jobs in
health and education while reduced income taxes will favor retail jobs.
The recovery bill has been structured to generate spending at a much faster rate over
the next two years than typical infrastructure legislation:
1. In many cases, state and local governments are given deadlines to commit to
projects. If they do not meet those deadlines, the money will be allocated to
other states ready to spend it.
2. The bill's guidelines also favor projects with faster spend-out rates.
3. Because of the fiscal bind of most state and local governments, matching
requirements are waived.
Current conditions also favor faster than normal spend-out rates:
1. State and local governments have many ready-to-go infrastructure projects that
they have had to put on the shelf under current budget pressures.
2. With so much economic slack – particularly in construction, the necessary labor,
equipment, and materials can be staged to move into place more quickly.
3. Some infrastructure projects are ready to go in 2009. Other projects are in the
pipeline and, with the incentives created by this bill, will be ready to go in 2010.
There are advantages to the fact that not all infrastructure spending will disburse in the
first year. When the Wall Street Journal recently asked various economists for their
remedies to address the current downturn, it quoted and paraphrased noted economist
Alan Blinder:
“The downturn is still young, it is going to go on for much longer, and it will be
very deep. 'We need to think of having time-release capsules,' he says, that will
help boost the economy a year from now. Infrastructure spending, which some
economists argue against because it takes awhile to be put in place, does
exactly
that.”
Net Addition to Federal Debt Much Less than Budgeted Cost
At the end of the day, the net fiscal cost of this bill will be substantially less than its
budgeted cost. Compared to what would happen if we failed to act, the bill will:
1. create jobs for people who would otherwise be unemployed;
2. generate sales at companies that would otherwise not occur; and thus
3. increase tax revenues and lower income support payments.
Mark Zandi projects that a $750 billion recovery package along the lines being proposed
would raise GDP by $2.9 trillion over the next four years – about four times as much as
the initial cost. He projects that GDP will be about $1 trillion higher in both 2011 and
2012. For every dollar of increased GDP, federal revenues tend to go up by more than
$0.20. If Zandi's estimate of the effect on GDP is anywhere close to correct, the true
net fiscal cost of the bill would be very modest and the deficit will be substantially lower
in 2011 and 2012 than without the recovery package. It is worth noting that fiscal
stimulus could have such a substantial effect on GDP and therefore revenues over such
a long period only because the base case is so dire – 11 percent unemployment in 2010
and GDP not recovering its 2008 level until 2012. In less dire economic times, such a
modest net budget cost of spending and lower future deficits would not be possible.
High Bang for the Buck
Unlike the stimulus bill of early 2008 that provided only tax cuts, this recovery package
emphasizes the spending side because it provides more “bang for the buck” under
current conditions. The tax rebates last spring showed that Americans have become so
concerned about their debt and saving that they will not spend a large fraction of any tax
cut. Over the last two decades, Americans’ saving rate went from 8 percent of income
to near zero. Many were running up debts as they tried to make ends meet with
stagnant or declining real income. Others felt confident in spending all their income and
becoming highly leveraged as they enjoyed rising wealth from homes and stocks
without having to save. All that has changed. Credit to financially stressed families has
dried up. Falling home and stock prices are causing the net worth of middle and higher
income households to shrivel up. While the first group can be counted on to spend their
tax cuts, that is not the case of families more concerned with their shrinking net worth.
As we saw in the spring, a sizable fraction of any tax cut to them will be used to pay
down debts and not be spent. The same logic applies to tax cuts for corporations who
have become more obsessed with reducing their excessive leverage than in hiring or
investing.
The proposed increases in federal spending, on the other hand, will have nearly
complete pass through to additional demand for goods and services.
1. Because infrastructure projects are ready to go or soon will be, they will lead to
direct spending in the next two years.
2. Federal relief for state and local operating budgets will prevent them from making
cuts in spending or increases in taxes of an almost equal amount in the next two
years.
3. Economically stressed families will increase spending by as much as their
unemployment insurance, food stamp, and other financial help goes up.
Studies done by the Congressional Budget Office and by Mark Zandi have found that
providing income to lower income people – through unemployment insurance, food
stamps, or tax cuts – have the highest “bang for the buck” in terms of deficit cost (as
well as meet humanitarian goals).
Fear Shifting from Inflation to Deflation
Although inflation worries were widespread as recently as last summer, a growing
number of economists have become quite concerned about the opposite, falling prices
or deflation. For example, the recently released minutes of the monetary policy
committee of the Federal Reserve reveal a growing concern about deflation. The U.S.
has not experienced deflation since the Great Depression. Deflation reinforces a
downward economic spiral for several reasons. It gives people an incentive to postpone
purchases to get a lower price later. It also discourages businesses from investing
because they fear that they will not be able to make a return on their investment,
especially if they must take on debt to finance investment.
Since the credit crunch hit with full force in September, prices of crude and intermediate
goods have been falling sharply – not only for energy but for non-energy categories.
We also observe rapidly declining prices in major inputs to infrastructure projects. For
example, prices for steel rebar plunged 36 percent from August to December. Prices of
asphalt have dropped even more in most parts of the country. Falling demand and
rising capacity is also putting downward pressure on cement. With so much excess
capacity from falling private demand, we should expect a major push on infrastructure to
help stabilize prices but not to raise them in general. Nevertheless, out of concern that
some capacity bottlenecks could develop, the Committee has been somewhat more
restrained in infrastructure investments than some have urged.
Conclusion
Standing alone, this recovery package is not sufficient to deal with the depth of the
current economic crisis. Combined with other needed actions, however, it should make
an important contribution to alleviating the current crisis by
• helping to end the recession sooner and to create a faster recovery;
• producing assets in the form of infrastructure, technology, and skills that will
strengthen our economy for the future;
• reducing the amount by which state and local governments raise taxes and
reduce education, health, and public safety programs;
• increasing jobs by almost four million next year and by millions more after that;
• creating a substantial increase in national output and income over the next few
years such that its net fiscal cost will be modest overall and bring about lower
deficits in future years; and
• providing important assistance to low income families laid low by the current
downturn.
