By Francis M. Bator
Shoring up lenders, unclogging lending, even direct action to limit the slide in house prices, will no longer suffice to prevent a severe recession. Only public or private spending on output will prevent spiralling cutbacks in production, jobs and incomes.
Action to boost spending should be temporary, phased out as the economy recovers. But it should be large enough to make a difference. It takes about $500bn growth in total spending each year just to keep unemployment rates and capacity utilization constant. Each extra percent of unemployment costs $250bn-300bn per year in lost pre-tax wages and profits.
Here are two examples of fiscal action that would be easy to implement, quick to boost spending, and unusual enough to make timely reversal credible.
1: To keep revenue-starved states, cities, and towns from slashing spending and raising taxes, raise by a flat, across the board percentage – say by a quarter or even a half – every cash grant the Treasury makes to state and local governments. An increase by a quarter would boost their revenues by $95bn, or 5 per cent.
2: Reduce by a flat, across-the-board percentage federal payroll taxes. A 25 per cent reduction would increase take-home pay by about $250bn per year. Cash-constrained households, perhaps half of all households, would quickly spend the money. Even most of the rest would probably increase their spending.
What about the deficits and debt?
With a large and growing pool of unemployed workers, lots of unused production capacity, and the Federal Reserve aggressively depressing interest rates, extra deficit spending will not displace either business capital spending or the production of goods for export.
The boost in sales is more likely to cause business to increase investment. And absent any displacement of domestic and US foreign investment (exports less imports), deficit spending will not reduce by a penny how much real and financial wealth our children and grandchildren will inherit (including what we own abroad less what we owe abroad.)
For Americans taken as a whole, additional government borrowing from Americans, adding to Americans’ holdings of government debt, will be a wash: tax-paying Americans will owe the borrowed money, and the interest on the money, to bond-holding Americans.
The only extra ongoing burden that such domestic borrowing will place on our heirs is relatively small potatoes: the distortion of incentives caused by the taxes that will be needed to pay the interest. And to the degree that we borrow the money from foreigners, and as long as there is no displacement of investment, the increase in our indebtedness abroad will be offset by the increase in productive real capital at home and in foreigner’s indebtedness to us. In any case, a deep recession is much more likely to scare away foreign lenders and investors, than responsible, recession-countering increases in deficit spending.
Inflation is not a real worry either. Even a sizable preventive fiscal push is unlikely to overheat a slack, rapidly slowing economy threatened by deep recession. Producers worried about falling sales will not want to turn away buyers by marking up prices. Workers threatened by layoffs are not likely to demand, never mind receive, large increases in wages.
Even before the economy softened, the huge run-up in raw material prices last spring and summer notably failed to trigger the sort of catch-up wage demands that ignited the 1970′s wage-price spiral. As Japan discovered, in this sort of situation a falling price level is the greater danger. Happily, in the US that is most unlikely.
That said, the president-elect should prepare the ground for necessary long term action (as well as allay ill-timed deficit anxiety) by creating, immediately after the election, a high-powered task force to prepare by January 20 a multi-year post-recession budget plan to kick in once the economy has safely turned.
The plan should call for a gradual shift of the federal structural operating budget first into balance, and then, over time, into a substantial surplus, i.e. net federal saving to supplement grossly inadequate private saving.
The roles assigned to spending cuts and tax increases, and the kinds of spending cuts and tax increases, should initially reflect the new president’s priorities. But he should then lead a national debate about how we should divide the national product – currently about $150,000 per American family of average size, and likely to increase on average by 1.75 per cent to 2 per cent per year.
How much should go for public investment, both hard and soft, and for public services, as against business investment and personal consumption? The plan should pay particular attention to health care, education and research, infrastructure, energy and climate change, and what if anything we should do to assure a decent minimum standard of consumption for the truly disadvantaged, and their children.
We argue endlessly about taxes and government spending in no relation to what allocation of the GDP we want those policy instruments to aim at. Yet whatever the government does about its budget, and the Federal Reserve about money, will powerfully affect those choices.
Francis M. Bator is Littauer professor of political economy, emeritus, at the Harvard Kennedy School of Government
