There is an amusing piece from Peter Ferrara in Forbes, comparing the Obama recovery with the recovery under Ronald Reagan. The conclusion of the author is that the Reagan recovery was much stronger and that this is evidence of failed Obama policies (which, in another column, he compares to Swedish socialism).
The recoveries compared
Much of the article is a barrage of figures that show that the recovery under Reagan was much stronger, and grosso modo we have no beef with that, it's true. The interesting part is why this is the case. Ferrara argues:
In fact, since the American historical record is the worse the recession, the stronger the recovery, Obama should have had an easy time producing a booming recovery by now
Since the "Obama" recession was very steep, "his" recovery should have been very strong as well. Since it wasn't this is clear evidence of his failed policies. It's sort of funny, as a couple of years earlier he argued this:
When President Reagan entered office in 1981, he faced actually much worse economic problems than President Obama faced in 2009.
But hey, in polemic economic writings who says one has to be consistent. To compare the recoveries, we have to compare the recessions. The essential point is that both crises were very different in nature.
The recession of the early 1980s, and subsequent recovery, was a classic business cycle recession produced by economic overheating, inflation increased, and the Fed raises interest rates to unprecedented levels (21.5% in 1980) in order to cool off the economy and kill inflation. This produced a recession. If you don't believe us, believe Ferrara:
The contractionary, tight-money policies needed to kill this inflation inexorably created the steep recession of 1981 to 1982.
While the recession was quite deep, after inflation was beaten interest rates could be lowered enormously, leading to a V-shaped recovery. Mythology is crediting Reagan's tax cuts and deregulation for the recovery but this isn't really visible in the figures, as:
- There was no subsequent lasting investment boom
- There was no subsequent productivity boom (bar one that started in the second half of the 1990s)
- There is a much easier way to explain the recovery, the drastic fall in interest rates
- The same recipe didn't work under Bush in the first decade of the 21th century
The simple fact is that the economy moved down when interest rates were increased (a lot) and recovered equally fast when interest rates came down (a lot), hence the V-shaped Reagan recovery, which should really be the Volcker recovery (if one keeps in mind that it was also Volcker's recession).
The recession if 2008-9, by contrast, couldn't really produce such a V-shaped recovery through lowering interest rates as these were already almost zero. This is because this recession was of a very different nature; it wasn't a garden variety business cycle recession but one brought about by an asset price collapse after a speculative asset bubble burst.
The excess was caused by the private sector on financial markets, excessive speculation and credit creation (sub-par mortgages) fueled an asset price boom that subsequently fell under its own weight, leaving debt on balance sheets of the private sector and banks, but wiping out asset prices ($9 trillion was lost in house values alone).
The damage to balance sheets result in spending and credit cuts, putting the economy in a prolonged slump that can easily feed on itself if policy reaction isn't right on the mark. We know this from the 1930s, with numerous policy failures, but also from Japan in the 1990s.
We could say that US policy post-2008 was sufficient to keep the economy from spiraling down in a Fisherian debt-deflationary spiral but insufficient to give it the escape velocity back to normal, basically because fiscal stimulus turned into fiscal drag way too soon. Here is why:
In the figure above, you see how the private sector swung from a huge financial deficit (investment exceeding saving) to a huge surplus (saving exceeding investment). That is no surprise:
- Households increased savings and reduced spending, despite record low interest rates, in order to repair their balance sheets.
- Banks reduced credit creation in order to repair their balance sheets.
- Firms reduced investment as banks reduced credit creation and households reduced spending.
You can also now see why:
- Monetary policy is quite powerless: households won't borrow, despite record low interest rates as they're paying off debt, rather than borrowing more.
- The economy can easily spiral down, like in the 1930s. The reduction in household spending can feed on itself, creating reduced investment, rising unemployment, even lower spending, and all the while, traditional monetary policy is unable to stop this, as households won't borrow more at any rate.
This can result in a Fisherian debt-deflationary downwards spiral, where spending gets so low as to produce falling prices, and falling prices increase the real debt burden, worsening balance sheets further, producing more spending cuts in an effort to repair them -- a nasty vicious cycle.
Is there anything policy makers can do about this? Well:
- Since traditional monetary policy doesn't work in this situation (short-term interest rates are essentially zero), unconventional monetary policy can be tried, like QE.
- If the private sector is cutting back spending in order to repair balance sheets, the public sector could step in and take up the slack to keep the economy from spiraling down.
Both of these options are vehemently opposed by Ferrara.
Unconventional monetary policy
When the Fed can't lower interest rates that were responsible for the V-shaped recovery in the 1980s because rates are already zero, what about other monetary means? Well, not quite, according to Ferrara:
And instead of adopting monetary policies that would produce a stable dollar, Obama's monetary polices have mimicked the devaluationist ones previously embraced by George W. Bush on the way to sagging investment, and with the latter, slow growth.
Obama's Fed has thrown oil on the bonfire with its zero interest rate, and runaway quantitative easing policies. With those policies having been in place for years now, they are the foundation of the current economy, which is just another bubble that will pop when the Fed tries to implement any exit strategy.
Apart from the fact that there seems to be very little dollar devaluation, Ferrara might want to keep an eye on Japan where unconventional monetary policy looks like finally bringing Japan out of a deflationary slump caused by a similar (but much bigger) asset price implosion 20 years ago. One could also argue that unconventional monetary measures from the Fed almost certainly stopped an ongoing financial meltdown in 2008 in its tracks.
And how the economy can be both a bubble and the worst recovery in history at the same time is also a bit of a mystery to us.
Increased public spending
Increased public spending to take up the private sector slack is complete anathema for the Ferraras of this world, arguing that:
- The stimulus didn't work
- Public spending should have been cut instead
Taxing or borrowing a trillion dollars out of the private sector to spend a trillion dollars in the public sector is not going to increase jobs or economic growth overall on net. At best, it will just shift jobs from where the market directs to where the government directs. More likely, it will be a net drag on the economy, because the market spends money more productively and efficiently than the government.
This is a rather basic mistake of applying full employment economics to a depressed economy where the private sector is still deleveraging and monetary policy has lost most of its traction. An economy characterized by the latter behaves very differently and is characterized by lots of idle resources. Indeed:
- Unemployment and underemployment is most likely way above 10% (we actually agree here with Ferrara, who fails to see the consequences of this)
- Companies are sitting on lots of spare capacity and $2T of cash hoards
- Banks are sitting on large amounts of excess reserves.
That is, many resources sit idle. They could be employed if there was sufficient demand for products and services, but there isn't because monetary policy isn't effective, there is fiscal drag, rather than fiscal stimulus, households are still deleveraging and banks are cautious after a period of excess.
When there are idle resources because of lacking demand, re-employing resources even when organized by the government doesn't go at the expense of the private sector, quite the contrary. It creates income, which will be spend in the private sector, and under the present circumstances this has a very large multiplier effect, as even the IMF has recently argued.
Ferrara makes the same basic mistake as those who argued, as far back as 2009, that the stimulus would produce large public deficit that would send interest rates sky-high and "crowd out" the private sector or that QE would lead to hyperinflation.
This hasn't happened at all four years later, for the same reasons that QE hasn't created even the slightest increase in inflation (let alone the predicted runaway inflation), in a balance sheet recession, people save more (to pay down debt). So savings go up and credit demand from the private sector goes down, so much so that even zero interest rates cannot revive credit demand sufficiently to get the economy back on track and QE mainly leads to large excess bank reserves.
And the private sector generates plenty of savings that keep interest rates on Treasuries from going up, despite record public sector deficits and debts. We know this -- it has happened before -- like in Japan for the last two decades. It isn't a mystery.
In fact, Ferrara isn't just against the stimulus, he wants to cut back public spending:
Reagan proposed budget cuts to the fiscal year 1981 budget, which totaled $681 billion, resulting in a cut of nearly 5% in that budget. Obama could have done the exact same thing when he entered office in January, 2009, even more so with the Congress totally controlled by his own party at the time.
Cutting spending when there is a large amount of slack in the economy and monetary policy being unable to compensate the reduction in demand isn't a good idea as we've already mentioned that the IMF has shown that the fiscal multiplier is especially large under these circumstances, so spending cuts will have large contractionary effects. If you have doubts, go to Greece, Portugal, Ireland, Spain, Japan in 1997, The US in 1937, etc.
How to organize the demand that's lacking? Well, we could invest in our future. The US has a large deficit in infrastructure, which could employ many people laid off after the housing construction boom subsided. We could rebuild the education system, put money into basic research, etc. But all this is anathema to Ferrara, who is worried about a Greece style fiscal crisis, while not acknowledging that the US issues its own currency while the eurozone countries can't.
The relevant country is Japan, not Greece, and we see that no bond vigilantes have emerged in two decades of balance sheet recession with large fiscal deficits and public debt at 230% of GDP. The US has ample time to deal with any such situation, should it ever emerge, and the deficit is already reducing fast.
Public spending and the 1980s recovery
In fact, a case can be made that public expenditures even played a considerably bigger role in the 1980s recovery. Here is Krugman, explaining the real per capita growth in public spending three years into the respective presidencies:
Under one president, real per capita government spending at that point [first quarter of 1984] was 14.4 percent higher than four years previously; under the other, less than half as much, just 6.4 percent [first quarter of 2012]
How come? Wasn't Reagan all about reducing the size of government? Well:
Reagan's big military buildup played some role. But the big difference was real per capita spending at the state and local level, which continued to rise under Reagan but has fallen significantly this time around.
In case you still have doubts:
Public sector employment
Ferrara slams Obama on his employment record:
Obama's so-called recovery included the longest period since the Great Depression with unemployment above 8%, 43 months, from February, 2009, when Obama's so-called stimulus costing nearly $1 trillion was passed, until August, 2012
For starters, the job performance could also be compared with what happened after similar financial crises; the picture does change quite a bit:
And the funny thing is, despite articles titled "President Obama: The Biggest Government Spender In World History" in which he argues:
His whole mission is to transform the U.S. not into a Big Government country, but a Huge Government country... That is why he is at minimum a Swedish socialist, if not worse.
Strong rhetorical stuff, but as it happens, it's just that. It's a little early to compare foodstamps with the cradle to grave Swedish welfare state and socialized healthcare.
Speaking of government, it's actually public employment that fared much worse under Obama compared to most other presidents. If Obama is masterminding to build a Swedish welfare state, he's doing it in stealth mode and with ever fewer employees. Remarkable stuff.
Here is the WSJ last year:
The jobs count that it bases its payroll figures on - shows that the government has been steadily shedding workers since the crisis struck, with 586,000 fewer jobs than in December 2008.
Things haven't improved with the sequester and the situation is probably considerably worse:
But the survey of households that the unemployment rate is based on suggests the government job cuts have been much, much worse. (WSJ)
Economic recoveries compared
Ferrara argues that the Obama recovery was the worst on record in US history, but comparing it to other recoveries from the 2008 financial crisis changes the picture quite dramatically:
This is important, because the policy mix in most of these countries was actually much more what Ferrara prescribes; austerity, sound monetary policy, even a currency union that functions like the gold standard in the 1930s (reintroducing the gold standard is a favorite of Forbes, where Ferrara writes his columns).
While we don't dispute that deregulation or lowering taxes on business could get some traction in a country like France or Italy, in the US there is zero evidence this would produce any benefits in the US.
Corporations are already sitting on $2T of cash, they produce record profits and have ample spare capacity and their tax bill amounts to little over 1% of GDP. What they face is a lack of demand, a problem that Ferrara's solution of "sound" monetary policy and austerity would only have increased dramatically.
The US under Obama hasn't done so bad, but it could have done much better, but not by taking economic advice from the likes of Peter Ferrara.
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