How Should Policymakers Respond to the Employment Report?

Here's more on the employment report from The Economist:

Postpone the optimism, The Economist: Not long ago economists and policymakers in America clung to hopes that the economy, after lurching through the depths of a financial crisis earlier this year, would rebound in the second six months. Such hopes look all the more forlorn now. On Friday September 5th a depressingly downbeat August employment report was released. The unemployment rate leapt to 6.1% from 5.7% in July. It now stands only just below the 6.3% peak that it reached in the last slump, in mid-2003.  ...

If there is a silver lining to the payroll report it is that, despite eight straight months of declining payroll employment, the pace of contraction has yet to approach that which is typically seen in recessions. On average, since December, 76,000 jobs have been lost each month, equivalent to a monthly decline of 0.06%. From March 2001 to February 2002, the average decline was 169,000, or 0.13%. The better position today may be explained, in part, by the relative strength of exports, without which manufacturing would be shedding jobs at an even faster pace. No doubt the speed with which monetary and fiscal stimulus was brought to bear has also helped. Another factor may be that, during the economic expansion, employers were not quick to hire workers, which left little obvious fat for them to cut now. ...

[P]oliticians ... must now respond in the heat of a campaign. The weak economy probably plays to the advantage of congressional Democrats and the Democratic presidential candidate Barack Obama, who have been pressing for a second stimulus package focused more on government spending than on tax rebates. The latest news may weaken Republican opposition to such a package both in Congress and by John McCain.

The news, unhappily, also makes the job of the Federal Reserve a bit simpler. Its inflation worries in the past month have receded because of welcome news (the big drop in oil prices) and because of less welcome news, such as the higher unemployment figures. That makes it all the more likely that the Fed will not raise interest rates from the current 2% before the end of the year. The latest news may also mollify hawks on the policymaking Federal Open Market Committee...

I think that's right with respect to monetary policy, as increasing the interest rate is not a chance we should take at the moment. We should probably be satisfied if monetary policy can simply keep the economy treading water for the moment. Any stimulus beyond that will need to come from fiscal policy, or from the economy self-healing (which is unlikely in the short-run).

If we go the fiscal policy route, and I think we need to, my preference is for government spending rather than for tax cuts because it has a more certain effect on aggregate demand, and within the government spending category the preference is for spending on government investment (infrastructure). However, government investment is difficult to bring online quickly (though compensating for losses in state revenue can be implemented quickly, and this can help by preventing states from cutting back on existing infrastructure projects), so some combination of government consumption or transfer payments for the short-run impact, and government investment for the more sustained impact, would be required.

The first stimulus package was a one-shot tax cut rather than a sustained stimulus, and that wasn't enough, so if a fiscal policy package is implemented, hopefully this time will be different.

Comments

[Matt Blackman:]

What the heck, let's get the government to spend, spend, spend our way back to prosperity. Who cares how big deficits and debt gets. We'll just inflate our way out of it... NOT!

As we learned from the 1930s, increasing trade barriers and taxes is not the answer, see sfomag.com/Article.asp...

2008 Sep 07 01:37 PM

[woodsey:]

Investing in infrastructure is not throwing money away. I say let's go for it.

2008 Sep 07 03:19 PM

[tinman:]

Borrow & Spend is obviously the Policy of Success. Let's bite the bullet, cut taxes to zero, and borrow the whole enchilada! What could possibly be better than that?

2008 Sep 10 09:49 PM