The collapse on Wall Street is now decimating
Main Street, Ocean Parkway, Mountain View Drive and I-80.Since January
the economy has shed 760,000 jobs. In September alone, monthly mass layoff
claims for unemployment insurance jumped by 34 percent. General Electric,
General Motors, Chrysler, Yahoo! and Xerox have all announced major layoffs,
along with the humbled financial titans Goldman Sachs and Bank of America.
Fully one quarter of all businesses in the United States are planning
to cut payroll over the next year. State governments are facing a tax
revenue shortfall of roughly $100 billion in the next fiscal year, 15
percent of their overall budgets. Because states have rules requiring
balanced budgets, they are staring at major budget cuts and layoffs. The
fact that the economy’s overall gross domestic product (GDP) shrank between
July and September the first such decline since the September2001 terrorist
attacks only confirms the realities on the ground facing workers, households,
businesses and the public sector.
The recession is certainly here, so the question now is how to diminish
its length and severity. A large-scale federal government stimulus program
is the only action that can possibly do the job.
So far, our leaders in Washington have dithered. Treasury Secretary Henry
Paulson and Federal Reserve chair Ben Bernanke continue improvising with
financial rescue plans, committing eye-popping sums of money in the process.
Paulson’s original program for the Treasury to commit $700 billion in
taxpayers’ money to purchase “toxic” loans- the mortgage-backed securities
held by the private banks that are in default or arrears- was at least
partially shelved in favor of direct government purchases of major ownership
stakes in the banks. But neither of Paulson’s strategies has thus far
helped to stabilize the situation, with global stock and currency markets
gyrating wildly and investors dumping risky business loans in favor of
safe Treasury bonds. The crisis has even hit the previously staid world
of money market mutual funds, where the fainthearted once could park their
savings safely in exchange for low returns. Money market fund holders
have been panic-selling since mid-September, dumping $500 billion worth
of these accounts.
To stanch a money market fund collapse, Bernanke announced on October
21 that, on top of the Paulson bailout plan, the Fed stands ready to purchase
$540 billion in certificates of deposit and private business loans from
the money market funds. This action is in addition to two previous initiatives
committing the Fed to buy up, as needed, business loans from failing banks.
Until this crisis, the Fed had conducted monetary policy almost exclusively
through the purchase and sale of Treasury bonds, rarely buying directly
the debts of private businesses or banks. But the pre-crisis rules of
monetary policy are out the window.
Even if some combination of Treasury and Federal Reserve actions begins
to stabilize financial markets in the coming weeks, this will not, by
itself, reverse the deepening crisis in the nonfinancial economy. A rise
in unemployment in the range of 8 to 9 percent- upward of 14 million people
without work- is becoming an increasingly likely scenario over the next
year.
President-elect Obama as well as most members of the newly elected Democratic-controlled
Congress seem to recognize the urgency of such a large-scale stimulus
program above and beyond any financial bailout program. Even Bernanke,
whose term of office continues through January 2010, has offered his endorsement.
But despite the near consensus, questions remain, including: How should
the stimulus funds be spent? How large does the stimulus need to be? Where
do we find the money to pay for it?
A Green Public-Investment Stimulus
Recessions create widespread human suffering. Minimizing the suffering
has to be the top priority in fighting the recession. This means expanding
unemployment benefits and food stamps to counteract the income losses
of unemployed workers and the poor. By stabilizing the pocketbooks of
distressed households, these measures also help people pay their mortgages
and pump money into consumer markets.
Beyond this, the stimulus program should be designed to meet three additional
criteria. First, we have to generate the largest possible employment boost
for a given level of new government spending. Second, the spending targets
should be in areas that strengthen the economy in the long run, not just
through a short-term money injection. And finally, despite the recession,
we do not have the luxury of delaying the fight against global warming.
To further all these goals we need a green public-investment stimulus.
It would defend state-level health and education projects against budget
cuts; finance long delayed upgrades for our roads, bridges, railroads
and water management systems; and underwrite investments in energy efficiency
including building retrofits and public transportation as well as new
wind, solar, geothermal and biomass technologies.
This kind of stimulus would generate many more jobs- eighteen per $1 million
in spending- than would programs to increase spending on the military
and the oil industry (i.e., new military surges in Iraq or Afghanistan
combined with “Drill, baby, drill”), which would generate only about 7.5
jobs for every $1 million spent. There are two reasons for the green program’s
advantage. The first factor is higher “labor intensity” of spending- that
is, more money is being spent on hiring people and less on machines, supplies
and consuming energy. This becomes obvious if we imagine hiring teachers,
nurses and bus drivers versus drilling for oil off the coasts of Florida,
California and Alaska. The second factor is the “domestic content” of
spending- how much money is staying within the US economy, as opposed
to buying imports or spending abroad. When we build a bridge in Minneapolis,
upgrade the levee system in New Orleans or retrofit public buildings and
private homes to raise their energy efficiency, virtually every dollar
is spent within our economy. By contrast, only 80 cents of every dollar
spent in the oil industry remains in the United States. The figure is
still lower with the military budget.
What about another round of across-the-board tax rebates, such as the
program the Bush administration and the Democratic Congress implemented
in April? A case could be made for this in light of the financial stresses
middle-class families are facing. However, even if we assume that the
middle-class households will spend all the money refunded to them, the
net increase in employment will be about fourteen jobs per $1 million
spent- about 20 percent less than the green public investment program
(the main reason for this weaker impact is the lower domestic content
of average household consumption).
Also, it isn’t likely that the households would spend all their rebate
money. Just as with April’s rebate program, households would channel a
large share of the money into paying off debts.
The Matter of Size
This is no time to be timid. The stimulus program last April totaled $150
billion, including $100 billion in house hold rebates and the rest in
business tax breaks. This initiative did encourage some job growth, though
as we have seen, the impact would have been larger had the same money
been channeled toward a green public-investment stimulus. But any job
benefits were negated by the countervailing forces of the collapsed housing
bubble, the financial crisis and the spike in oil prices. The resulting
recession is now before us. This argues for a significantly larger stimulus
than the one enacted in April. But how much larger?
One way to approach the question is to consider the last time the economy
faced a recession of similar severity, which was in 1980–82, during Ronald
Reagan’s first term as president. In 1982 gross domestic product contracted
by 1.9 percent, the most severe one-year drop in GDP since World War II.
Unemployment rose to 9.7 percent that year, which was, again, the highest
figure since the ’30s.
The Reagan administration responded with a massive stimulus program, even
though its alleged free-market devotees never acknowledged as much. They
preferred calling their program of military expansion and tax cuts for
the rich “supply-side economics.” Whatever the label, this combination
generated an increase in the federal deficit of about two percentage points
relative to the size of the economy at that time. In 1983 GDP rose sharply
by 4.5 percent. In 1984 GDP growth accelerated to 7.2 percent, with Reagan
declaring the return to “morning in America.” Unemployment fell back to
7.5 percent.
In today’s economy, an economic stimulus equivalent to the1983 Reagan
program would amount to about $300 billion in spending- roughly double
the size of April’s stimulus program, though in line with the high-end
figures being proposed in Congress. A stimulus of this size could create
nearly 6 million jobs, offsetting the job-shedding forces of the recession.
Of course, the green public-investment stimulus will be much more effective
as a jobs program than the Reagan agenda of militarism and upper-income
tax cuts. This suggests that an initiative costing somewhat less than
$300 billion could be adequate to fight the job losses. But because the
green public-investment stimulus is also designed to produce long-term
benefits to the economy, there is little danger that we would spend too
much. Since all these investments are needed to fight global warming and
improve overall productivity, the sooner we move forward, the better.
Moreover, under today’s weak job market conditions, we will not run short
of qualified workers.
How to Pay for All This?
Let’s add up the figures I have tossed around. These include the $700
billion bank rescue operation being engineered by the Treasury, the $540
billion with which Fed chair Bernanke has pledged to bail out the money
market mutual funds, along with unspecified additional billions to buy
unwanted business debts held by banks. On top of these, I am proposing
$300 billion for a second fiscal stimulus beyond last April’s $150 billion
program. At a certain point, it is fair to wonder whether we are still
dealing with real dollars as opposed to Monopoly money.
In fact, the whole program remains within the realm of affordability,
albeit approaching its upper bounds. But major adjustments from the current
management approach are needed. In particular, the Federal Reserve has
to continue exerting control over the Treasury on all bailout operations.
That is, we need more initiatives like Bernanke’s $540 billion program
to stabilize the money market mutual funds and less Treasury fumbling
with taxpayers’ money to buy either the private banks’ bad assets or ownership
shares in the banks.
We need to recognize openly what has largely been an unspoken fact about
these bailout operations: that the Federal Reserve has the power to create
dollars at will, while the Treasury finances its operations either through
tax revenues or borrowed funds (which mean using taxpayer money at some
later time to pay back its debts with interest). The Fed does not literally
run printing presses when it decides to inject more money into the economy;
but its normal activity of writing checks to private banks to buy the
banks’ Treasury bonds amounts to the same thing. When the banks receive
their checks from the Fed, they have more cash on hand than they did before
they sold their Treasury bonds to the Fed. Especially during crises, there
is no reason for the Fed to restrain itself from making good use (though
of course not overuse) of this dollar-creating power.
The Fed is also supposed to be the chief regulator of the financial system.
Now is the time to make up for Alan Greenspan’s confessed failures over
twenty years in this role. In exchange for the Fed protecting the private
financial institutions from collapse, Bernanke must insist that the banks
begin lending money again to support productive investments, while prohibiting
them from yet another return to high-rolling speculation. Special measures
are also needed to keep people in their homes.
The Deficit Looms
When the economy began slowing this year, the fiscal deficit more than
doubled, from $162 billion to $389 billion. We cannot know for certain
how much the deficit will expand. It could rise to $800 billion, $1 trillion
or even somewhat higher, depending on how the bailout operations are managed.
Of course, it would be utterly self-defeating for the United States to
run a reckless fiscal policy, no matter how pressing the need to fight
the financial crisis and recession. But in the current crisis conditions,
even a $1 trillion deficit need not be reckless.
Let’s return to the Reagan experience for perspective. In 1983 the Reagan
deficits peaked at 6 percent of the economy’s GDP. With GDP now around
$14.4 trillion, a $1 trillion deficit would represent about 7 percent
of GDP, one percentage point higher than the 1983 figure.
Of course, the global financial system has undergone dramatic changes
since the 1980s, so direct comparisons with the Reagan deficits are not
entirely valid. One change is that government debt is increasingly owned
by foreign governments and private investors. This means that interest
payments on that debt flow increasingly from the coffers of the Treasury
to foreign owners of Treasury bonds.
At the same time, as one feature of the crisis, Treasury bonds are, and
will remain for some time, the safest and most desirable financial instrument
in the global financial system. US and foreign investors are clamoring
to purchase Treasuries as opposed to buying stocks, bonds issued by private
companies or derivatives. This is pushing down the interest rates on Treasuries.
For example, on October 15, 2007, a three-year Treasury bond paid out
4.25 percent in interest, whereas this past October 15, the interest payment
had fallen to 1.9 percent. By contrast, a BAA corporate bond paid 6.6
percent in interest one year ago but has risen this year to 9 percent.
As long as the private financial markets remain gripped by instability
and fear, the Treasury will be able to borrow at negligible interest rates.
Because of this, allowing the deficit to rise even as high as 7 percent
of GDP does not represent a burden on the Treasury greater than what accompanied
the Reagan deficits.
There is, then, no reason to tread lightly in fighting the recession,
with all its attendant dangers and misery. Indeed, severe misery and danger
will certainly rise as long as timidity- the path of least resistance-
establishes the boundaries of acceptable action. The incoming Obama administration
can take decisive steps now to defend people’s livelihoods and to reconstruct
a viable financial system, productive infrastructure and job market on
the foundation of a clean-energy economy.