September 18, 2014

Bernanke on Going Big in Both Ways

NOTE: an earlier version of this post appears on EconomistMom.com

It would seem we have heard this so many times before that we shouldn't need to hear it again. The U.S. faces two major economic challenges at the same time: (1) an economy still desperately struggling to get out of (or avoid falling back into) recession; and (2) a fiscal outlook on such an unsustainable longer-term path that it threatens our near-term, and not just longer-term, economic health. The first is mostly a "lack of demand" problem, and the second is more about failing to keep up the supply of productive resources in our economy. The two challenges are very different and might suggest very different policy strategies, but we really can and should address both. We've heard this ("we can do both") principle many times before, but it always helps when someone as prominent as the Chair of the Federal Reserve Board makes it crystal clear in his written and oral (and official) remarks. From Bernanke's testimony before the Joint Economic Committee (on Tuesday), emphasis added:

To be sure, fiscal policymakers face a complex situation. I would submit that, in setting tax and spending policies for now and the future, policymakers should consider at least four key objectives. One crucial objective is to achieve long-run fiscal sustainability. The federal budget is clearly not on a sustainable path at present. The Joint Select Committee on Deficit Reduction, formed as part of the Budget Control Act, is charged with achieving $1.5 trillion in additional deficit reduction over the next 10 years on top of the spending caps enacted this summer. Accomplishing that goal would be a substantial step; however, more will be needed to achieve fiscal sustainability.

A second important objective is to avoid fiscal actions that could impede the ongoing economic recovery. These first two objectives are certainly not incompatible, as putting in place a credible plan for reducing future deficits over the longer term does not preclude attending to the implications of fiscal choices for the recovery in the near term. Third, fiscal policy should aim to promote long-term growth and economic opportunity. As a nation, we need to think carefully about how federal spending priorities and the design of the tax code affect the productivity and vitality of our economy in the longer term. Fourth, there is evident need to improve the process for making long-term budget decisions, to create greater predictability and clarity, while avoiding disruptions to the financial markets and the economy. In sum, the nation faces difficult and fundamental fiscal choices, which cannot be safely or responsibly postponed.

And don't just take our monetary policy leader's word for it.  Listen as well to Doug Elmendorf, the director of the Congressional Budget Office, which obviously makes him one of our top fiscal policy advisers.  From Doug Elmendorf's testimony before the Joint Select Committee on Deficit Reduction (a.k.a. the "super committee") on September 13th--again, emphasis added:

There is no inherent contradiction between using fiscal policy to support the economy today, while the unemployment rate is high and many factories and offices are underused, and imposing fiscal restraint several years from now, when output and employment will probably be close to their potential. If policymakers wanted to achieve both a short-term economic boost and medium-term and long-term fiscal sustainability, a combination of policies would be required: changes in taxes and spending that would widen the deficit now but reduce it later in the decade. Such an approach would work best if the future policy changes were sufficiently specific and widely supported so that households, businesses, state and local governments, and participants in the financial markets believed that the future fiscal restraint would truly take effect.

We’ve been facing these dual economic challenges for a long time now, and the policy prescription to address both concerns—rather than incorrectly believe we have to choose between creating jobs and reducing the deficit—isn’t a new idea either.  Back in January of 2009—nearly three years ago(!)—the Concord Coalition put out this issue brief on “Designing a Framework for Economic Recovery and Fiscal Sustainability.” Note the “and” (no “or”)—and that we still haven’t succeeded in either.  In it we explained:

Deficit spending is an appropriate policy response to the current recession, but only for policies designed to stabilize the economy during the downturn. Committing to large and persistent deficit spending beyond the recession—even for apparently worthy purposes—would be detrimental to longer-term economic growth through reduced national saving. It would also contribute to the fragility of short-term economic recovery by undermining the attractiveness of U.S. Treasury debt to global investors, thus threatening our nation’s access to affordable credit…

Rather than setting a top-line goal and then rushing to fill it with policies that add up to the desired amount, great care should be taken to ensure that the policies are designed to meet critical needs. In that regard, the Obama administration and Congress should pursue a recovery strategy that combines:

1.      Deficit spending in the short term on policies that will quickly stimulate consumption, create jobs, or provide assitance to cash-strapped households;

2.      Critical public investments over the longer term that will ultimately increase our nation's productive capacity; and

3.      A long-term fiscal sustainability strategy focused on reforming health care, Social Security and the tax system.

To do the first effectively, deficit-financed policies must have a clearly countercyclical purpose and be effective at producing those benefits during, not after, the recession. To accomplish the second goal, deficit financing of longer-term investments should be evaluated through the normal budgetary process and designed to pass a cost-benefit test that accounts for debt service. To do the third effectively, the long-term cost of government commitments must be scaled back and sufficient revenues must be raised to pay for them.

I revitalized this old point last week in a column I wrote in the Christian Science Monitor. I go a little further than either Bernanke or Elmendorf in the argument that you can "do both," in that I believe we could actually do both at the same time, if we could better optimize our policies to get the best and most cost-effective results in terms of both short-term stimulus and longer-term growth. The basic strategy is to reduce deficit spending (including on tax cuts) that has proven to be ineffective at stimulating demand, in favor of more effective policies. Then we can either increase the “bang” for the same amount of “buck,” or achieve the same “bang” for a lot less “buck”—or anything in between. We’d then be better stimulating the economy in a more fiscally responsible manner. And to avoid deficit financing done in the name of stimulus turning into permanent deficit-financed policies, I reminisce in my column that:

For the short term, stimulus policies should adhere to the three T's that President Obama's former economic adviser Larry Summers first espoused: timely, well-targeted, and temporary. That means policies that as quickly as possible put more money in the hands of the households most likely to immediately spend the money on goods and services, and the businesses most likely to hire more workers.

And for the longer term, reducing the deficit needs to be less about what we’re cutting out and more about what would only then become possible:

Over the longer term, deficit reduction can encourage economic growth via higher national saving, while freeing up resources to go to the most productive areas of our economy. Then, instead of having a rising share of resources going toward interest on the national debt or other forms of government spending that provide no public benefits, more funds will get steered toward areas of government spending that our society values highly.

So, you hear a lot of "Go Big" advice to the super committee these days. But we can and should “go big” in "both ways"—to address as well as we can, both of the major challenges facing the economy. We need more jobs, and we need lower deficits—and we need both right now.