Fiscal policy failed us during the Great Recession. We did get a fiscal stimulus package shortly after Obama took office, and it helped. But it wasn’t big enough and did not last long enough to make the kind of difference that was needed. Fear of deficits stood in the way, though all the dire predictions that were made about the debt associated with the stimulus package did not come to pass. We could have done so much more.
For mild recessions, monetary policy alone is enough to turn the economy around and restore full employment. All the Federal Reserve has to do is lower interest rates to stimulate new spending and the problem is solved. But in severe recessions, when the Fed lowers interests rates as low as they can go and it’s still not enough to reverse the fall, fiscal policy is needed as well.
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What type of policy? The precise details depend upon the type of recession we are experiencing, but there are some general guidelines. To begin, the policies must be temporary. A crisis is not the time to try to push ideological changes through Congress, e.g. new, permanent spending programs or permanent cuts in taxes. That leads to gridlock as each side tries to block the other’s proposals. New spending initiatives and tax cuts must be reversed once the economy regains its footing.
In addition, the proposals should be budget neutral in the long-run. The deficit may increase during the recession, but we should pay it off with spending cuts and tax increases once things improve. Finally, the stimulus should be directed at the households who are struggling the most, and at solving the problem causing the recession. For example, during the Great Recession we should have done a lot more to help the unemployed find work, or, failing that, help them pay the bills, and we could have done a lot more to help reverse the losses to households due to the crash of housing and financial markets.
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What can be done to improve fiscal policy? One answer is to mimic William Dudley’s call for an improved culture in the financial industry as a way of avoiding financial crashes, only in this case the cultural improvement is needed in Congress. Even if the people in need are not likely to vote, or are members of the other political party, that’s no reason to let people struggle when help is available.
After the initial stimulus package, which was far from sufficient in both size and duration, Congress all but turned its back on the unemployed. And it made the problem even worse by turning to austerity and failing to help state and local governments who were struggling with reduced tax revenue and increased demand for services due to the recession. Balanced budget requirements forced state and local governments to layoff workers, and Congress did little to help. We could have and should have helped those in need, but the culture in Washington stood in the way.
But I’m not very hopeful that Congress will change its ways voluntarily, any more than I think the financial system will change on its own. So what else can we do? Another answer would be to create an independent, Fed style committee in charge of making recommendations for fiscal policy during recessions. Unlike the Fed, the committee wouldn’t actually set fiscal policy, it would only make recommendations to Congress (preferably a plan that is budget neutral over a period of years, and a plan that would take effect unless Congress votes it down).
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The problem is that deep recessions don’t occur very often, so the committee would only meet on rare occasions, and Congress is unlikely to listen anyway. But it would at least put a non-ideological, temporary, targeted, balanced budget proposal on the table that Congress would have to actively ignore. As for the problem of meeting only rarely, this duty could be given to the Fed, i.e. when interest rates hit the zero lower bound the Fed would then make fiscal policy recommendations, but there’s a chance that would politicize the Fed in a way that could threaten its independence. If Congress would listen, a separate committee is probably best.
In the end, it’s very frustrating and discouraging. Temporary, timely, and targeted fiscal policy in deep recessions could help so many people. It could make a huge difference for those who are struggling to make ends meet, and it could help the economy recover faster. But Congress seems unable to find its way past ideological gridlock even when people are in so much need, and there doesn’t seem to be a good way to solve that problem.
At least we’ll still have an independent Fed to rely upon when recessions hit, and to do what is needed to regulate the financial industry in a way that will minimize the chance of another large recession and the need for fiscal policy. Or will we? Many Republicans would like to eliminate the Fed, or reduce its independence substantially, and overturn Fed regulation of the financial industry. It would be a big mistake to lose the only policymakers able to act when the economy has trouble.
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