Our economic wounds are self-inflicted. Changing fiscal and monetary policies could make a difference fast..
By JOHN B. TAYLOR
It’s been three years since the financial crisis flared up and the recession began. Yet the unemployment rate is still over 9%—double what it was before the recession—and it’s been stuck above 9% for 20 consecutive months. Why the extraordinarily high and prolonged unemployment? My research shows that discretionary government interventions—deviations from sound economic principles and policies—have been largely responsible.
Many government interventions occurred before the panic in the fall of 2008, but in the past two years the government doubled down. We have seen an $862 billion stimulus, an increase in federal spending to 25% from 21% of GDP, and a corresponding explosion of federal debt. We have the Fed’s unconventional “quantitative easings”: purchases of $1.25 trillion of mortgage backed securities and $900 billion of longer-term Treasury bonds. And we have seen hundreds of new regulations in the health and financial sectors.
The one-time stimulus payments to people did not jump-start consumption. The stimulus grants to states did not increase infrastructure spending. Cash for clunkers merely shifted consumption a few months forward. The Fed’s purchases did not have a material impact on mortgage interest rates once changes in risks are taken into account. At best these actions had a small temporary effect that dissipated quickly, leaving a legacy of higher debt, a bloated Fed balance sheet and uncertainty—all of which slow growth and job creation.
None of this should be surprising. Well-known theories of consumption predict that temporary payments to households will not increase economic growth by much. Careful empirical studies of stimulus programs in the 1970s showed that stimulus grants to states did not increase infrastructure spending. A vast literature and experience from the 1970s show that discretionary monetary policy, as distinct from rules-based policy, leads to boom-bust cycles with ultimately higher unemployment and higher inflation. With sounder, more stable and more predictable monetary and fiscal policies in the 1980s and ’90s we had long expansions and lower unemployment.
The best way to reduce unemployment is to restore sound fiscal and monetary policies. There are some welcome signs that the policy pendulum has begun to swing back in that direction. The recent election revealed deep concern about high debt, deficits and spending.