How Fiscal Ideology Trumped Job Creation

by: Felix Salmon

Ben Bernanke was hardly shy about straying into fiscal territory yesterday:

If the nation is to have a healthy economic future, policymakers urgently need to put the federal government’s finances on a sustainable trajectory. But, on the other hand, a sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery. The solution to this dilemma, I believe, lies in recognizing that our nation’s fiscal problems are inherently long-term in nature. Consequently, the appropriate response is to move quickly to enact a credible, long-term plan for fiscal consolidation. By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk.

And I don’t think it’s a coincidence that today sees the publication of Zachary Goldfarb’s big 2,200-word profile of Tim Geithner, banging the same drum, and contrasting it explicitly with the need for further economic stimulus.

Geithner’s efforts inside the White House have shaped how Obama confronts this defining moment. At stake in the months ahead are the size of government, the generosity of the nation’s safety net, the taxes people will pay and the debt that will weigh on future generations…

By early last year, Geithner was beginning to gain the upper hand in a rancorous debate over whether to propose a second economic stimulus program to Congress, beyond the $787 billion package lawmakers had approved in 2009.

Lawrence Summers, then the director of the National Economic Council, and Christina Romer, then the chairwoman of the Council of Economic Advisers, argued that Obama should focus on bringing down the stubbornly high unemployment rate. This was not the time to concentrate on deficits, they said.

Peter Orszag, Obama’s budget director, wanted the president to start proposing ways to bring spending in line with tax revenue.

Although Geithner was not as outspoken, he agreed with Orszag on the need to begin reining in the debt.

The way that Goldfarb puts it, it’s pretty clear that Geithner’s actions have resulted in less stimulus and a weaker social safety net. I’m particularly interested in the “rancor” within the White House on this question, given that I thought there was a consensus on the issue, in terms of what the best policy should be: pay for a second stimulus now with the proceeds of a credible long-term deficit-reduction strategy. The message I’ve been getting — and I’ll admit that my ears are not well attuned to Washington nuance — is that we’d all love a second stimulus on such terms, but that it’s a political impossibility given the make-up of Congress, and that therefore there’s no point in even trying.

But now it seems that Geithner, for one, is actually quite vehemently opposed to any second stimulus, even in the context of long-term fiscal reform.

Once, as Romer pressed for more stimulus spending, Geithner snapped. Stimulus, he told Romer, was “sugar,” and its effect was fleeting. The administration, he urged, needed to focus on long-term economic growth, and the first step was reining in the debt.

Wrong, Romer snapped back. Stimulus is an “antibiotic” for a sick economy, she told Geithner. “It’s not giving a child a lollipop.”

In this debate, Romer is right and Geithner is wrong. For one thing, economic growth isn’t necessarily the only or even the best way to create jobs, as this chart from Jared Bernstein shows - (click chart to expand):

There’s a risk, if you concentrate too much on economic growth and too little on job creation, that you’ll just build an economy with increasing returns to capital and decreasing returns to labor, where productivity gains get dividended out to plutocrats rather than resulting in new employment opportunities. And even if you agree that economic growth is a great way to create jobs, it’s not at all obvious that deficit reduction is a better way to jumpstart growth than stimulus. Quite the opposite, in fact. Which is why I have a lot of sympathy with Andrew Stern here:

Andrew Stern, former president of the Service Employees International Union, said in an interview that Geithner looks at the world “from his experience, which is predominantly a Wall Street, Treasury, fiscal and monetary policy point of view.”

Geithner cut his teeth in a world of bond vigilantes, an era when James Carville said that he would like to be reincarnated as the bond market, because then he could intimidate everybody. And after that, Geithner dealt with a series of international sovereign-debt crises where countries found themselves hammered by enormous bond spreads.

But right now the 10-year bond is yielding less than 3% even after the debt ceiling has already been reached and the government is in frantic moving-money-around mode to try to avoid drastic cuts or even default. Clearly it’s not high long-term interest rates which are holding back economic growth. And although it’s all well and good for Geithner to talk about building a credible long-term fiscal strategy, where I part ways with him is the idea that such a strategy is incompatible with short-term stimulus. Indeed, I think we need a short-term stimulus to get enough Americans working again that tax revenues can rebound healthily and make a serious dent in the deficit.

It’s clear at this point that such a stimulus is not going to happen. The result is going to be devastating for millions of needlessly-unemployed Americans — and also for the fiscal health of the country as a whole. Geithner, it seems, deserves to shoulder a large part of the blame for that.