8
STIMULUS, STIMULUS, WHEREFORE ART THOU, STIMULUS?
If we do not move swiftly, an economy that is already in crisis will be faced with catastrophe.
—PRESIDENT BARACK OBAMA, FEBRUARY 5, 2009
John Maynard Keynes, the great British economist, died in 1946. But his ghost lives on. When economies around the world contracted sharply in late 2008 and early 2009, government officials started seeing visions of the 1930s and turned immediately to the teachings of Lord Keynes. For central bankers, that meant slashing interest rates to the bone and opening the monetary spigots—though the monetary systems of many countries were badly clogged by the financial mess. For presidents and prime ministers, congresses and parliaments, going Keynesian meant cutting taxes, raising public spending, or both. The idea in all cases was the same: to give total spending a badly needed boost, a stimulus.
But in the United States and much of Europe, the attachment to Keynesian economics was and remains skin-deep. For whatever reasons, Keynesian policies have always been controversial in the United States, and associated with the liberal side of the political spectrum—despite President Nixon’s famous proclamation that “I am now a Keynesian in economics.” So most Republicans opposed Keynesian stimulus from the get-go—branding fiscal stimulus as an incursion into free markets, an expansion of government, and wasteful to boot. The partisan battle over stimulus in the opening weeks of the Obama administration helped sow the seeds of the severe backlash that would come later.
A TERRIBLY TIMED TRANSITION
The long transition period in 2008–2009 was terribly timed. The U.S. economy was weak and getting weaker when Senator Barack Obama was elected president on November 4, 2008. But it was in far worse shape when he was finally sworn in seventy-seven days later. According to the payroll survey, we lost 489,000 jobs in October 2008, the first full month after the Lehman bankruptcy. Then we lost another 2.3 million jobs while the president-elect waited in the wings: 803,000 in November; 661,000 in December; and 818,000 in January. The economy was sinking like a ship taking on water, and jobs were sinking with it as frightened employers pared their payrolls. No wonder the satirical newspaper the Onion led its November 5 edition with this tongue-in-cheek headline: “Black Man Given Nation’s Worst Job.”
Then another big problem got dropped into the economic hopper. Five days after the election, General Motors, once among the mightiest of America’s corporations and still employing almost 100,000 people, announced that it would run out of cash around the middle of 2009 unless it received government assistance, sold assets, or was merged into another company. (GM subsequently shortened its time frame.) GM was not alone. A long streak of bad business decisions, plus effective foreign competition, plus rising oil prices, which made gas guzzlers unattractive, had brought the U.S. auto industry to its knees. Then came the severe recession, threatening to deliver the knockout blow.
On November 18, 2008, the CEOs of GM, Ford, and Chrysler all showed up at a congressional hearing trying—unsuccessfully, as it turned out—to solicit federal aid. Displaying amazingly deaf political ears, all three flew to Washington—to plead for taxpayer assistance—on their corporate jets! Appearances aside, bankruptcy for Detroit’s Big Three looked like a real possibility that would have dire consequences for their dealers, suppliers, and workers. Not to mention for states like Michigan and Ohio. Not to mention for the staggering national economy.
On December 19, the ultraconservative President Bush let pragmatism trump ideology and tapped the TARP for multibillion-dollar bridge loans to both GM and Chrysler. (Ford was in better shape.) “Bridges to what?” many people asked. Well, basically, bridges to the incoming Obama administration, which was forced to add yet another big headache to its to-do list. (The ball is in your court, Barack.) The “auto bailout,” as it would come to be called, would eventually have President Obama’s name and fingerprints all over it. But in December 2008, he was not yet president.
Although Chairman Bernanke and the Fed were still working monetary policy hard, the lack of presidential leadership during those critical months hurt. Finding President Bush was a bit like playing “Where’s Waldo?” You knew he was in there somewhere, but for the most part, the outgoing president was neither seen nor heard. CBS News estimated that he spent nearly a third of his time on vacation, often at his Texas ranch. It seemed like more. The president appeared to be alarmingly out of touch and had apparently delegated management of the economic crisis entirely to his secretary of the Treasury.
President-elect Obama, on the other hand, was seen and heard often. He was all over the media. The American public naturally turned to their new leader—who had run on a platform of “change”—with great anticipation. After all, an African American had just been elected president of the United States. Didn’t that mean he could walk on water? Expectations for Barack Obama ran so high that he could only disappoint them.* But until January 20, 2009, he didn’t have the power to do anything—except to form a team and make plans.
To deal with the burgeoning economic catastrophe, President-elect Obama assembled what many at the time called a “Dream Team.” For secretary of the Treasury, he tapped Tim Geithner, who was smart, deeply experienced, and battle-tested from fighting financial crises both in the Clinton Treasury and as president of the New York Fed—but who, therefore, also carried with him the political baggage from Bear Stearns, Lehman Brothers, AIG, and the rest. Geithner apparently edged out Larry Summers, who had been Bill Clinton’s last secretary of the Treasury and wanted his old job back. Ironically, Geithner had followed Summers up the Treasury ladder during the Clinton administration, starting as Summers’s personal assistant in 1993 and finishing as one of his undersecretaries in 2000. All the while, he had been Summers’s underling—until now.
That looked like a potential problem when Obama turned around and appointed Summers to be his national economic adviser, director of the National Economic Council (NEC). Everyone knew that Summers was brilliant; if you ever forgot, he was eager to remind you. But while he was among the smartest people on earth, he was not among the best organized. He was also acerbic, domineering, and argumentative. Perhaps not the ideal character traits for the role of NEC director, who is supposed to be the “honest broker” among competing interests and personalities on the president’s economic team. Pretty soon, Geithner and Summers were sparring, albeit in a generally friendly manner. According to one of their administration colleagues, “[Larry] viewed Tim as junior to him. While he respected the office, he thought of Tim at some level as a grad student who needed feedback and critiques.”
For budget director, Obama nominated economist Peter Orszag. Though just forty years old, Orszag had accumulated a wealth of valuable experience as director of the Congressional Budget Office (CBO) and was an acknowledged expert on the federal budget—and especially on health care, which would come in handy. The appointment drew nothing but applause. According to the Washington Post, “On Capitol Hill, the reactions to Orszag bordered on bipartisan bliss.”* But it wasn’t long before Orszag and Summers were practically at war.
Rounding out the quartet of top economic advisers, the president-elect nominated Christina “Christy” Romer, a University of California, Berkeley, professor who, like Bernanke, was an expert on the Great Depression, to chair his Council of Economic Advisers (CEA). Romer was virtually unknown in Washington, and she, in turn, did not know Washington. Nor did she have any preexisting relationship with Obama—unlike Austan Goolsbee, who had been the campaign’s chief economic adviser and who was awkwardly placed below Romer.
The Dream Team was soon having nightmares. Orszag clashed repeatedly with Summers and was the first member of the quartet to depart (in July 2010). Romer, who showed a lot of backbone in a job with little inherent power, followed a few months later. Journalist Ron Suskind reported that she felt “increasingly isolated in her job, excluded from the broader discussion by Summers.” As she left, she declared Summers to be one of her best friends, thereby ruining her reputation for honesty. Summers himself left the White House at the end of the year. Each had worked his or her fingers to the bone. Only Geithner, the primus inter pares, lasted two years; and he stuck it out past the 2012 election.
That settled the economic team’s structure, right? Wrong. President-elect Obama then added a bunch of “czars” with special responsibilities for crucial areas of policy—and who did not report to either Geithner, Summers, or Orszag. Specifically, Nancy-Ann DeParle was named health care czar,* and Carol Browner was named energy and climate change czar. Two talented and experienced people, but aren’t health care and energy/climate issues of economic policy? How could DeParle and Browner be in charge if there was a secretary of the Treasury and an NEC Director? A good question—to which Summers apparently had a ready answer: They weren’t.
Finally, there was the wild card, Gene Sperling. Sperling, who had held the top NEC post in the second Clinton administration, was given a kind of bigshot-without-portfolio position at the Treasury—a job specifically created to give him a seat at the table. Officially, he was a counselor to the secretary. But, in fact, Sperling was granted a kind of roaming license, enabling him to pop in on issues and meetings of his choice. Being a remarkable bundle of energy who could outwork and outlast almost anybody, Sperling naturally chose almost everything. When Summers departed, Sperling assumed the top NEC job.
It was a talented team, to be sure. But Summers’s bull-in-a-china-shop manner was worrisome. And with Geithner and Summers occupying the top rungs, it all appeared—and probably was—a bit too pro–Wall Street for the times. Besides, the players were slotted into the org chart from hell. How would it all work? Orszag later told Suskind that it didn’t: “I think part of the problem was the lines of organization were so jumbled from the start that no one was quite sure of their role, or what they were supposed to be doing. What is the economic team? What is the health care team?”
There was also a further problem, which would haunt the administration time and again. In this time of trauma and deep economic anxiety, with new policies flying around at warp speed, who would be the administration’s principal economic spokesman? Who would explain things to the people? Fixing the economy was going to be a long, hard, complicated slog. Who had the eloquence and persistence to provide a narrative to a frightened and bewildered public?
The secretary of the Treasury is the obvious choice in most administrations. But everyone soon learned that, despite his many talents, Geithner was a terrible orator. Put him into a room to interact with a small group, ask him to think on his feet, give him knotty problems to solve, and he excels. I’ve witnessed it myself, many times. But put him in front of a microphone with a teleprompter and a large crowd watching as TV cameras roll, and he seems to turn wooden. His clipped manner of speech and staccato delivery just don’t work as oratory, and his diminutive physical stature doesn’t help, either.
What about Summers, then? As a former professor, he could certainly deliver a coherent, well-organized speech, replete with alliterative adjectives, arresting adverbs, and meaningful metaphors—and he could do it all without notes. (Remember, he was brilliant.) But somehow Summers’s speeches always came across as mixtures of arrogance and grouchiness. While Summers would prove to be hugely influential behind the scenes, the administration was loath to use him as its public face. Orszag may or may not have coveted the role. But he didn’t get it. It fell to Romer to fill it more than anyone else on the economic team—even though the CEA chair was the lowest-ranked member of the quartet, was supposed to be the ultimate technocrat, and had no past history with Obama.
In truth, the job of principal spokesperson on economic policy fell to politicos like David Axelrod—who were not the best equipped to do it—or to President Obama himself, which meant that it mostly went begging. During the crisis and its aftermath, the eloquent young president delivered amazingly few speeches on the economy and his economic policies. No wonder the American people never really “got it,” never formulated a clear mental picture of how we got into this mess, never understood how Obama’s policies were supposed to get us out, and never bought the argument that things would have been much worse without the stimulus, the TARP, and all that. Instead, Obamanomics was an incoherent blur to most citizens—and not a very successful blur, at that. The president and the country would pay a steep price for his failure to communicate, to educate, and to convince.
LASER BEAM OR SCATTERSHOT?
During the transition, and intensifying after Inauguration Day 2009, the American people focused intently on their disintegrating economy. Sure, there were two wars going on and a variety of other pressing issues. But there was little doubt about what was foremost on people’s minds. In James Carville’s memorable words, it was the economy, stupid. A Gallup poll released right before Inauguration Day found that about 76 percent of respondents chose either the economy, unemployment, or “lack of money” as the most important problem facing the nation. The top noneconomic concern, the Iraq war, polled just 13 percent. After all, a disaster was unfolding, and Americans found themselves dragooned into being unwitting extras in a bad movie. They were looking desperately for a John Wayne character to ride to their rescue. How would the dynamic new president pull us out of the nosedive? He could pull rabbits out of hats, couldn’t he?
Bill Clinton, the previous Democratic president, had famously pledged during his transition to “focus like a laser beam on the economy.” It helped frame and define the Clinton presidency. Barack Obama apparently wanted no such constraining frame. He intended to do much more, including health care. So he made no such defining declaration. And it hurt him badly.
Not that focusing like a laser beam on the economy would have left Obama a lot of spare time to sharpen his golf game. The new president had to lead the economy out of the deepest recession since the 1930s—presumably with a big fiscal stimulus package. He had to make sure the economy then grew fast enough to create jobs, jobs, jobs—for nearly 3 million jobs had been lost since Lehman Day in September 2008, and another 4.3 million would disappear before payrolls finally bottomed out in February 2010.
He also had to, first, apply multiple tourniquets to the bleeding financial system, and then nurse it back to health—using whatever was left of the hated TARP, among other things. While doing so, he had to combat the coming tsunami of home mortgage foreclosures, which would otherwise throw millions of American families out of their homes. Then he almost certainly had to develop and propose sweeping reforms of the financial regulatory system, which had failed the nation badly, with horrific consequences. And he needed a plan for either bailing out the Big Three automakers or limiting the fallout from their demise. Okay, now exhale.
That was a vastly longer to-do list than Clinton had inherited. And almost every item on it would require that Obama shepherd highly controversial legislation through a contentious and highly partisan Congress. Furthermore, this list is limited to the economic issues that he had no choice but to deal with—the mandatories, you might say. But there were also the optionals, including big and complex issues like health care reform, which he had campaigned hard on, and energy and climate-change policies, which were also near and dear to his heart. Besides all this, there were many not-so-optional items outside the economic sphere, like the ongoing wars in Iraq and Afghanistan, which would just not go away. And whatever could be done about Pakistan. And ending torture and closing Guantánamo. And dealing with illegal immigration. And more.
All this would have constituted a daunting to-do list for a veteran political hand with extensive executive experience, deep Washington connections, and intimate knowledge of how to pull the levers of Congress. It was surely the toughest policy agenda to face a new president since Franklin Roosevelt in 1933. But in January 2009, it was all handed to a young, rookie president whose total national political experience consisted of two years as a U.S. senator before he went into campaign mode. Just four and a half years earlier, Barack Obama had been teaching law at the University of Chicago and serving in the Illinois State legislature.
The new president made a fateful decision early on, one that would define his presidency. He would try to be a transformational president. He would not limit himself to the must-dos; rather, he would take on other big things that needed attention. (Was this the Emanuel principle in action?: “You never want a serious crisis to go to waste.”) Or, to put a less favorable spin on it, he would adopt a scattershot approach, trying to do everything at once, rather than “focus like a laser beam on the economy.” Geithner objected, insisting to his new boss, “Your signature accomplishment is going to be preventing a Great Depression,” to which Obama responded: “That’s not enough for me.”
It was in many ways an admirable decision. For example, Democratic presidents had been striving for universal health insurance since Truman in 1947, without success. Could this, finally, be the moment? (It was.) If so, could Obama let the moment pass? (He didn’t.) But historians will long debate whether it was a wise decision. One White House aide later confessed, “No one thought we would have to take every element of the administration and dedicate it to health care both publicly and privately, which is what we ended up having to do.” They should have known that.
Among its many side effects, Obama’s decision to try to do everything at once meant that his personal attention, and that of his administration, would be scattered across a myriad of complex issues. It meant that the congressional circuits would be overloaded and that the new president would find his political capital spent profligately on a vast portfolio of issues. It left the public confused about what Barack Obama really stood for. What was this new president’s agenda? “Everything” is not an answer. Most germane to the themes of this book, the lack of focus meant that the public never acquired a clear picture of President Obama’s economic strategy. (Let’s see now. How does giving the uninsured health care help us out of the recession?)
And there was one more huge problem—an insuperable barrier, actually. Candidate Barack Obama had declared his intention to get past the bitter partisanship that had characterized the Clinton and Bush II years. He said he wanted to be a postpartisan president: “If we think that we can use the same partisan playbook where we just challenge our opponent’s patriotism to win an election, then the American people will lose. The times are too serious for this kind of politics.” After the election, one White House aide recalled to journalist Noam Scheiber, “We all believed that the vote was so strong from the public . . . that Republicans would have to be bipartisan.”
The naïveté makes me wince even today. A bipartisan tango takes two, and congressional Republicans were in no mood to dance. Rather, as Senate Minority Leader Mitch McConnell (R-KY) later admitted with startling honesty, “The single most important thing we want to achieve is for President Obama to be a one-term president.” When President Obama met the U.S. Congress in January 2009, the Republicans were armed for bear.
MEANWHILE, BACK AT THE FED
There were no Republican-versus-Democratic squabbles at Federal Reserve headquarters on Constitution Avenue, although the usual arguments between hawks, who always seem fixated on inflation, and doves, who agonize over unemployment, continued. By late 2008, however, the Fed’s policy agenda was pretty clear. Bernanke and his colleagues were still focused on doing whatever they could to rescue the faltering financial system and to cushion the recessionary blow.
The December 16, 2008, meeting of the Federal Open Market Committee (FOMC), the last during the Bush administration, turned out to be a landmark. During the three months that had elapsed since Lehman Day, a frail U.S. economy had descended into disaster, and the Fed had taken numerous drastic actions—most of which the central bank’s hawks didn’t like. Prior to the December 16 meeting, market speculation was rampant about what more the Fed should, could, and would do next.
There were three main candidates: The first was more conventional open-market policy. While the federal funds rate was already down to a superlow 1 percent, the FOMC could lower it still further. The markets thought a 50-basis-point cut most likely. Second, the Committee could try to reduce longer-term interest rates by committing to holding its overnight rate low for a long time. Some called that “open-mouth policy.” The idea is based on the expectations theory of the yield curve, which is explained in the accompanying box. Third, the Fed could keep on expanding its balance sheet, which had already soared from $924 billion the week before Lehman to $2,262 billion on December 11. Which option would the Fed choose?
It turned out to be all of the above. In the FOMC’s own language, it decided to use “all available tools” to fight the recession. Of course, Bernanke was inventing tools as he went along. For openers, the federal funds rate was slashed from 1 percent to a range between 0 and 25 basis points. It was the biggest rate cut in twenty-six years and more than the markets had expected. Over the next year, the effective federal funds rate would average 16 basis points.
Second, the Fed’s postmeeting statement added words of commitment “that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time.” English translation: We’re going to keep the funds rate in that range for quite a while, folks. Two meetings later, the FOMC changed the phrase “for some time” to the phrase “for an extended period,” which it would use until August 2011, when it changed its verbal commitment to keep rates low to “at least through mid-2013” and later to even longer periods than that.
Third, the FOMC promised further expansions of its balance sheet—on several fronts. It would “expand its purchases of agency debt and mortgage-backed securities.” It was “evaluating the potential benefits of purchasing longer-term Treasury securities.” (In Fed-speak, that meant it would definitely do it.) And it would begin purchasing private assets under the TALF (Term Asset-Backed Securities Loan Facility) “early next year.” (TALF purchases actually began on March 3, 2009.)
It was a trifecta, and markets stood up and cheered the Fed’s aggressive response. The S&P 500 rose 5 percent that day. The Fed’s hawks went along kicking and screaming (internally). The dire outlook was overwhelming their usual zeal for tighter money. The good news was that Bernanke and the FOMC doves were firmly in control. The bad news was that the Fed was nearly out of bullets. Eyes would now turn to fiscal policy.
PLANNING FOR FISCAL STIMULUS
The Obama transition team was busy formulating plans for a large fiscal stimulus package that would eventually become the American Reinvestment and Recovery Act of 2009 (ARRA)—the “Recovery Act” for short.
There had been a modest fiscal stimulus package under President Bush earlier in the year. The title of that bill had even used the word “stimulus,” which was not then a pejorative term to Republicans. In February 2008, with the perceived risk of recession rising, Congress passed the Economic Stimulus Act of 2008, and the president eagerly signed it into law. The act adopted the standard Bush remedy for everything: No matter what the problem, cut taxes. Specifically, most American taxpayers received a one-time income tax rebate ranging from $300 to $600 for single individuals and from $600 to $1,200 for married couples. There were also several business tax breaks, aimed at spurring investment, and, as always, a few stray cats and dogs. The one-year estimated cost of the package was about $150 billion, roughly 1 percent of GDP.
During the debate over that bill, economists, led by Larry Summers, then a private (but not a quiet) citizen, developed a catchy new catechism for any effective stimulus program: Such a program should be timely, targeted, and temporary—the three Ts. (It was the phrasing that was new, not the concepts.) The three Ts would come back to haunt Summers and his Obama administration colleagues a year later.
Timely meant that the stimulus should be fast-acting. That dictum put a big dent into some Democrats’ favorite idea: spending more money on public infrastructure. Building roads and bridges may be wonderful on the merits, many liberal economists said, but it doesn’t belong in a short-term stimulus package. The spend-out rates are simply too long and shouldn’t be rushed. If engineers tell us that the right amount of time to build a bridge is two years, but we rush it out in six months, would you want to cross it?
Targeted meant that the program should have a large aggregate demand “bang” for each government spending or tax cut “buck.” The federal government did, after all, have a budget deficit problem on its hands. Spewing out public money on items that didn’t add much to aggregate demand would widen the deficit without stimulating the economy much.
Temporary was obvious, and virtually inherent in the very idea of fiscal stimulus. Stimulus is not intended either to enlarge the public sector (as some of its critics claimed) or to shrink the revenue base (as some of those same critics desired). Rather, the basic idea behind fiscal stimulus is to boost aggregate demand in the short run and then go away. That way, we can stimulate the economy when necessary without damaging the long-run budget picture, which, even then, was dreadful.
While the precise amount is in dispute, there is little doubt that the 2008 tax rebates gave the U.S. economy a modest shot in the arm. But after the election, as the economy slid into what was starting to look like an abyss, that “modest” shot was clearly not enough. During the transition, Team Obama started planning for a much larger fiscal stimulus, to be introduced as one of the first acts of the incoming administration. As Goolsbee said on Face the Nation in November: “We’re out with the dithering; we’re in with a bang.” Translation: A stimulus of 1 percent of GDP was chicken feed.
Soon Obama’s stimulus plans were provoking fierce internal arguments and leaking like a sieve—or perhaps like a bunch of trial balloons. But the transition team probably had no idea what was about to hit them. To paraphrase Barney Frank again, the national commitment to bipartisanship lasted one day—not even. The era of good feeling was over even before Barack Obama was inaugurated.
According to press reports, President-elect Obama was going to ask for a stimulus package in the $700 billion to $800 billion range, roughly 5 percent of GDP. Too much, said Republicans. But liberals like Paul Krugman (publicly) and Christy Romer (privately) said it was too little. As the debate raged within the administration-in-waiting, these opposing criticisms from Left and Right may have made Obama feel that he was about in the right place.
A substantial chunk of the proposed stimulus would take the form of tax cuts, though more progressive ones than President Bush always favored. For example, the president-elect wanted (and got) a “Make Work Pay” tax credit that would be paid even to workers who earned too little to owe income taxes but who did pay payroll taxes. Republicans derided that idea as “welfare.” (Wait, aren’t payroll taxes taxes?) Another portion of the planned stimulus would go for infrastructure spending. Republicans didn’t like that idea, either; it was more government spending, not tax cuts. And a third big piece would be aid to state and local governments, so they would not have to slash their payrolls and raise taxes as much. Republicans opposed that, too, claiming it would not stimulate the economy. (How come? Aren’t government jobs jobs?)
And then there were the three Ts. Despite some external criticisms, including some friendly fire, the administration-in-waiting argued that the need for stimulus was likely to be far less temporary than in past recessions—after all, this one looked like a whopper, both very long and very deep. (Good point.) That thought, in turn, made infrastructure spending a more plausible candidate for stimulus. (Also a good point.) Even if the spend-out took two years, the economy would probably still need support in 2011. Infrastructure spending would still be timely. Besides, Obama’s team argued, they would concentrate the stimulus dollars on “shovel-ready” projects.* (Bad point. Never believe a governor or mayor who claims a project is shovel-ready.) I’ll return to targeted shortly.
THE ROCKY ROAD TO THE RECOVERY ACT
The House of Representatives eagerly went along with the new president—indeed, House members had conferred with Obama’s transition team on the details. With the large Democratic majority ushered in by the 2008 election guided by the firm hand of Speaker Nancy Pelosi, the House passed the stimulus bill on January 28, 2009, by a comfortable 244–188 margin. But not a single yes vote came from a Republican—not one. Republicans decried any federal spending as suspect and wasteful, even in a recession, and saw saving a government job as saving something that shouldn’t be saved. The Obama administration was a mere eight days old. It was a portent of things to come.
The fight was much harder in the Senate, where, as Harry Reid had explained to Hank Paulson, it take sixty votes to flush the toilets. Though in the minority, Senate Republicans used the threat of filibuster to force huge concessions out of Obama and the Democrats, including a variety of business tax cuts that the president didn’t want and which probably wouldn’t stimulate the economy much. In return, the “cooperation” they offered turned out to be exactly three votes. That isn’t much, but all three votes were essential. After numerous House-Senate differences were ironed out in conference, the final Senate vote was 60–38. The price tag placed on the ARRA at the time was $787 billion, or roughly 5.5 percent of GDP, though CBO reestimates subsequently raised the cost to around $830 billion.
Several noteworthy things happened along the rocky road to passage of the Recovery Act. Two would prove to be harbingers of things to come; two would create damaging symbols; and two would severely handicap any further fiscal stimulus.
The Harbingers
The first indicator of things to come was the immediate breakdown of bipartisanship. Did I say breakdown? In truth, bipartisanship never got started. The first two letters of bipartisan connote the need for two parties, but President Obama never had a partner on the other side. Apparently unwilling to believe that Republicans could be that obstinate, the new president reached out to them time and time again—and got next to nothing in return.
Which was the second harbinger: Obama, new to the job and new to Washington, proved to be a terrible bargainer, giving away the store in return for a few crumbs. He aimed to please, while they aimed to destroy—which produced lopsided results at the negotiating table. Remember, the Republicans controlled neither the White House, nor the Senate, nor the House at the time. Yet they won numerous concessions. Both Obama’s vain attempts at bipartisanship and his pliability at the bargaining table would become recurrent themes of his administration. Republicans reaped great political success as the “Party of No.” Democrats came to see Obama as a serial capitulator.
The Symbols
One unfortunate legacy of the tarring of the Recovery Act was the tarring of the name—and even the concept—of stimulus. Never mind that Bush’s 2008 tax cuts had been named the Economic Stimulus Act. Even before the ink was dry on the 2009 stimulus bill, Republicans were attacking it as misguided, futile, full of pork, ineffective, even a step toward socialism. Almost immediately after passage, they began a campaign to repeal it. The Republicans lacked the votes, but their campaign succeeded in giving stimulus in general, and the Recovery Act in particular, a bad name. When the economy proved to need more support in 2010, 2011, and 2012, no politician even dared utter the word “stimulus.” It had become an eight-letter word—sort of like two four-letter words.
The other symbol turned out to be the number 7, or rather $700 billion. The Recovery Act was originally, and erroneously, priced at $787 billion. The TARP legislation, which had passed just one hundred days earlier, appropriated $700 billion (but actually spent much less). The two three-digit numbers thus both started with the numeral 7. This coincidence invited confusion, and the TARP was reviled by everyone. Pretty soon, people started thinking that the stimulus bill had given away $700 billion to bankers. For example, a 2010 CNN poll found that 54 percent of Americans believed that the stimulus helped bankers and investors rather than the middle class. In fact, the stimulus had nothing much to do with the welfare of bankers and investors per se. (The TARP, of course, did.) It was a case of guilt by mistaken association.*
I must admit that when I first heard the numerology idea set forth by an astute veteran congressman, I dismissed it as ridiculous. Was anyone confusing J. D. Drew, then the Boston Red Sox’s journeyman right fielder, who wore number 7 on his back, with the New York Yankees’ immortal Mickey Mantle? But as I heard the confusion idea repeated by several other politicians—all of whom are in far better touch with ordinary people than we economists are—I started to believe it. After all, Americans pay closer attention to baseball than to public policy. It would not have taken much effort to boost the size of the stimulus package to, say, $802 billion, thereby eliminating the confusion. And it was eventually scored higher than that, anyway. But who knew at the time?
The Handicaps
As mentioned earlier, one of the three Ts was targeted: A well-designed stimulus should produce a lot of bang for the buck. But when it came to targeting jobs, the 2009 stimulus package earned a B at best. Let me explain why.
The basic philosophy behind creating jobs through fiscal stimulus might be called “build it and they will come.” Build a bigger GDP, and more jobs will come. It works because you need more labor to produce more goods and services. But it’s expensive for a simple reason. The United States is a rich country, with a highly productive workforce. Specifically, in 2010 there was about $112,000 worth of GDP for each payroll job. If stimulus creates average jobs by raising GDP, it should therefore cost about $112,000 of GDP per job created. By no coincidence, as we’ll see shortly, that number is close to the cost-per-job that the Obama administration and other macroeconomic modelers estimated for the 2009 stimulus package. Importantly, a $112,000 per job price tag doesn’t mean that the stimulus package was poorly designed. That’s why I gave it a B, not a D. To create jobs more cheaply, policy makers must go out of their way to target job creation explicitly.
How? One idea, which the incoming Obama administration considered but rejected, is called the new jobs tax credit (NJTC). Under such a plan, businesses would be offered, say, a $5,000 annual tax credit for each employee they add to their payrolls. If the average employee costs $50,000 a year, the effect is like cutting wages by 10 percent. The statistical evidence clearly shows that firms hire more workers when wages are lower, which is hardly a surprise. And estimates at the time suggested that the cost of the NJTC per job created would run in the $35,000 to $40,000 range, making it roughly three times as efficient as general fiscal stimulus.
Yet the incoming administration decided not to make the NJTC part of its stimulus plan—even though it is a business tax cut, which Republicans supposedly love.* Why not? There were some tricky technical issues to deal with; for example, you have to make sure businesses don’t get the tax credit by firing Peter and hiring Paul. But the biggest reason appears to have been that the idea garnered so little support from the business community, which was skeptical that the NJTC would work. Many businesspeople apparently told the president-elect and his advisers that it wouldn’t induce them to hire any more workers. A business tax cut without business support is dead in the political water.
But, as precious few people understand, these objections don’t undercut the efficacy of the policy. Notice that the cost estimate mentioned above is, say, $40,000 for each new job actually created, even though the tax credit is only $5,000 per job. That implies that the credit is “wasted” in seven out of eight cases. Even with such a high “failure rate,” the NJTC is almost three times more efficient at creating jobs than general fiscal stimulus. But the argument was too subtle by half. Try explaining it to a politician who is hearing negligible support from businesspeople in his home district, who prefer getting cash with no strings attached.
The second big handicap was a self-inflicted wound. On January 10, 2009, in response to mounting criticism, the Obama transition team released a study of the likely effects of its proposed stimulus program, coauthored by Christy Romer and Jared Bernstein, who would soon be Vice President Joe Biden’s chief economic adviser. Romer and Bernstein used conventional methods, similar to those of the CBO and other Keynesian macroeconomic modelers, and came to conventional conclusions. In particular, subject to admittedly large margins of error, they estimated that the stimulus package would raise real GDP at the end of 2010 by 3.7 percent and save or create nearly 3.7 million jobs. If you did the math, that came to about $118,000 per job—right in line with the economy-wide average mentioned above. In other words, theirs was a credible jobs estimate, not braggadocio. It did not imply miracles.
But here was their mistake. They translated this estimated jobs gain into achieving a 7 percent unemployment rate in 2010:4, instead of 8.8 percent without any stimulus. In fact, they said that if the stimulus program was enacted, the unemployment rate would never go above 8 percent. Never above 8 percent? It was already 7.8 percent in January 2009, though Romer and Bernstein didn’t know it at the time, and it would rise to 8.9 percent by April 2009—well before any stimulus program could have appreciable effects. The 8 percent number was silly from day one.
What happened? Both GDP and jobs were sinking like stones during the transition, making the Romer-Bernstein baseline forecast obsolete before it was published. Their analytical estimate implied that the stimulus would reduce the unemployment rate by about 1.8 percentage points (7 percent versus 8.8 percent) in 2010:4, which was reasonable.* But the actual unemployment rate in 2010:4 turned out to be 9.6 percent, even with the stimulus. And unemployment peaked at a horrific 10 percent, not 8 percent.
These appeared to be large errors, and the administration paid a heavy price for them. In particular, Republicans used the Romer-Bernstein peak-unemployment estimate of 8 percent as “proof” that the stimulus failed. The actual peak rate was 10 percent, wasn’t it? Yes, it was. But in the absence of the stimulus package, it would probably have been closer to 12 percent. But try proving that point to a skeptical public suffering from high unemployment—or to a hostile political opposition trying to embarrass you. The 8 percent peak-unemployment estimate was used over and over again to hammer the Obama administration in general and the stimulus program in particular. While wrong-headed, the criticism was effective. It was still used by Mitt Romney in the 2012 election campaign.
There is a moral here for policy makers—and for technicians who serve them. Don’t overstate your likely achievements; when in doubt, understate them. Had the two economists claimed that unemployment would peak at 10 percent with the stimulus or 11.8 percent without—or, better yet, just stuck with the 1.8-percentage-point unemployment decrease and not mentioned any levels at all—there would have been less criticism of their work, and less of the stimulus itself.
This advice is based on some personal experience. As a member of President Clinton’s original Council of Economic Advisers, I was in charge of the five-year forecast that we produced in a great hurry in January 1993. Being cautious about what we would claim, we made a forecast that turned out to be terrible. From 1993 to 1998, the U.S. economy vastly outperformed it in every respect. But I’ve never received a whit of criticism for the horrible forecast—and, more important, neither did Clinton. The economy did great, and nobody much cared about the errant forecast. Had the economy done worse than forecasted, however, there would have been hell to pay—as there was after 2009.
THE AMERICAN REINVESTMENT AND RECOVERY ACT
The American Reinvestment and Recovery Act (ARRA) passed the Congress on February 17, 2009, barely four weeks into the new Obama administration. That was fast work, though the process was painful. By the time the Recovery Act passed, whatever bipartisanship might have been latent in the Republican Party was gone. In round numbers, the bill was one-third tax cuts; one-third new spending, such as on unemployment benefits and infrastructure; and one-third aid to state and local governments, especially to help states pay their Medicaid bills.
In terms of the three Ts, the ARRA scored pretty well. Timely: The Act was passed speedily, close to the worst months of the recession, and spending ramped up quickly. From a standing start of zero, stimulus spending leaped to over $100 billion (over $400 billion at an annual rate) by the second quarter of 2009. Targeted: As discussed earlier, the ARRA was about average on this score. Temporary: The spending rate under the ARRA peaked in the second and third quarters of 2009, and then started a gradual decline. It was negligible by late 2011.
Did the Recovery Act work more or less as expected? Opinions are divided on this matter to this day. The highly publicized study by Zandi and me, published in July 2010, argued that it did. We were, predictably, praised by Democrats and excoriated by Republicans for saying that. (Googling “Blinder Zandi” turns up tens of thousands of entries, not all of them favorable!) Our numerical estimates corresponded well to those from other macroeconomic modelers in the Keynesian tradition—such as the CBO, Macroeconomic Advisers, and IHS Global Insight. The mechanism is straightforward: More government spending (or lower taxes) increases total demand in the economy; as firms produce more to meet this higher demand, they hire more workers. Simple, right? Apparently not, for several economists of the Right begged to differ. Among other things, they argued, our models were estimated only on past data (that’s true; what other data are there?) and did not take account of what actually happened after the ARRA passed. We just plugged the provisions of the stimulus package into a model of the past. (Also true.)
A February 2011 study by two politically independent economists, James Feyrer and Bruce Sacerdote, of Dartmouth College, addressed these criticisms. They assessed the effectiveness of the 2009 stimulus spending by comparing what actually happened to employment in states and counties that received differing amounts of ARRA money. Thus their methodology had nothing to do with Keynesian macroeconomic models estimated on historical data, and everything to do with what actually happened on the ground where the stimulus money was spent.
For the spending components of the ARRA (not the tax cuts), they estimated a $170,000 cost per job created, which is well above our estimate but within the range of estimation error. However, Feyrer and Sacerdote emphasized that the effectiveness of the spending depended sensitively on which parts you examined. In particular, they estimated that education grants to states created hardly any net new jobs. If you excluded them, the rest of the stimulus spending created jobs for under $100,000 each. Thus I read their estimates as saying that the macro models were not far from the mark. So do they.
Yet the fact that unemployment rose higher than 8 percent is still, to this day, used to “prove” that the stimulus package failed. During the vitriolic budget battles in 2011, Republicans constantly asserted that higher government spending “kills jobs.” How, I’ve always wondered, is that supposed to happen? When the federal government buys something from a private contractor, how does that destroy jobs? How could any government, even if it tried, spend over $800 billion without creating lots of jobs?
But you don’t get far in political discourse with counterfactual arguments that “it would have been even worse.” In 2009 and 2010, the public saw both a large stimulus package and a terribly weak economy. Republicans assured them that the former caused the latter. Democrats made their case poorly, or not at all.
THE EXPLODING BUDGET DEFICIT
There is another line of attack on the Recovery Act: that it raised the federal budget deficit. That is arithmetically true, of course. But the charge ignores the third of the three Ts. Stimulus spending is inherently temporary. According to CBO estimates, the ARRA raised the federal budget deficit by $183 billion in fiscal year 2009, a whopping $405 billion in FY2010, and $145 billion in FY2011 (which ended on September 30, 2011). For fiscal year 2012, the CBO’s budget-impact estimate is just $49 billion—with another $49 billion dribbling out over fiscal years 2013–2019. And these are all so-called static estimates; they do not include any feedback from stimulus to higher GDP and, therefore, to higher tax receipts. So the actual deficit impacts are smaller.
Yet the federal budget deficit ballooned from 3.2 percent of GDP in fiscal year 2008, a pretty normal number, to an astounding 10.1 percent of GDP in fiscal 2009—the largest deficit relative to GDP since World War II. Why? As table 8.1 shows, the lion’s share of the increase in the deficit came from losses of revenue and increases in “income security” payments attributable to the shrinking economy and to government efforts, via the ARRA and the TARP, to revive it.
TABLE 8.1 Deficit Alarm (changes in the federal budget, 2008–2009, in billions of dollars)
|
Category |
FY 2008 Budget |
FY 2009 Budget |
Change in Deficit |
|
Overall deficit |
$459 |
$1,413 |
+$954 |
|
Revenue, excluding ARRA |
$2,524 |
$2,174 |
+$350 |
|
ARRA revenue |
0 |
−$69 |
+$69 |
|
TARP |
0 |
$152a |
+$152 |
|
ARRA spending |
0 |
$114 |
+$114 |
|
Income securityb |
$261 |
$350 |
+$89 |
|
Total |
+$774 |
a TARP “spending” was not really spending, as virtually all of it was recouped. But it did raise the recorded deficit.
b Income security includes such categories as unemployment insurance compensation, SSI, nutrition programs, and the refundable portions of certain tax credits. Some of this was ARRA spending.
SOURCE: Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2011–2021, January 2011
Okay, so it was explicable. But trillion-dollar deficits were still appalling to most Americans. They felt wrong. This isn’t Greece—or Argentina. The U.S. government does not run budget deficits of 10 percent of GDP. With the budget deficit still stratospheric in 2010 and 2011, much of the often-raw politics was consumed by highly partisan debates over whom to blame for the deficit and how to reduce it quickly. In 2011 some Republicans even pushed for immediate budget balance, either by refusing to raise the national debt ceiling or by passing a balanced-budget amendment to the Constitution. Think about it: The fiscal year 2011 budget was in deficit to the tune of about $1.3 trillion, nearly 9 percent of GDP. A quick move to zero would almost certainly have led us straight into a deep recession. Yet this policy had many advocates.
It would be a rank understatement to say that the budget debates of 2010 and 2011 had a profoundly anti-Keynesian flavor. Had anyone roused the great Cambridge don from his grave, he would surely have groused that you don’t raise taxes or reduce government spending when your economy is in the doldrums. You do the opposite. Moreover, he would have been shocked to hear that anyone in 2011 was still asking the question. The Earth is not flat. The moon is not made of cheese. Evolution really happened. And you don’t give your economy a short-run boost by cutting public spending.*