Tie U.S. Recovery Program to Economic Indicators: Peter Orszag
According to early forecasts, the U.S. economy should already have recovered from the financial crisis. Despite some recent encouraging news, though, we still don’t know when things will be back to normal.
What have we learned from this delay? That in devising public policy to respond to the recession, it would have been smart to minimize the guesswork by relying more on automatic economic stabilizers.
This lesson is immediately applicable: Rather than simply extend the payroll-tax holiday for the rest of the year, Congress should link it to the unemployment rate.
Automatic stabilizers are components of the budget that cushion the blow from an economic decline, without the need for emergency congressional action. For example, when the economy weakens, tax revenue falls and certain forms of spending -- such as unemployment insurance -- automatically increase. The net result is to attenuate the impact of a recession, by providing stimulus right when it’s needed. As the economy recovers, the stabilizers recede, mitigating the longer-term effect on the budget deficit.
What’s crucial is that, once the automatic stabilizers are put in place, they do the work. They remove the need both to guess about the economy and to overcome legislative inertia.
In the U.S., automatic stabilizers offset about 20 percent of an economic shock after two years, according to research by Glenn Follette and Byron Lutz of the Federal Reserve. In Europe, the effect is even larger, research published by the National Bureau of Economic Research suggests. The automatic stabilizers in Europe offset a shock by about 10 percentage points more than in the U.S.
A report issued by the Congressional Budget Office last week illustrates how much automatic stabilizers have helped in the U.S. over the past three years and, at the same time, how much bigger they should be. The stabilizers have amounted to $1.1 trillion since 2009, the report shows -- significantly more than the stimulus delivered by the Recovery Act.
Each year since 2009, they have delivered about 2 percent to 2.5 percent of gross domestic product in fiscal stimulus. That is the largest sustained impact in recorded history, and it helped to make the hard slog of recovering from the financial slump a little less gruesome.
Nevertheless, the CBO projects an unemployment rate of 8.8 percent for this year. This is much higher than the agency had, a few years ago, thought it would be. (Judging by the January unemployment report, this prediction may be too pessimistic, underscoring the difficulty of economic forecasting.) In January 2009, the CBO projected an unemployment rate of 6.8 percent for 2012. At the time, the office was not alone in its relatively rosy outlook. Every official macro-econometric forecast in 2009 suggested we would see a V-type rebound rather than an L-type one, even though sluggish recoveries historically have followed financial crises.
So now imagine if more of the 2009 Recovery Act had been in the form of automatic stabilizers -- provisions linked to the unemployment rate -- rather than predetermined to fit a shorter and less severe decline than we have experienced. About two- thirds of the 2009 Recovery Act took the form of tax cuts, temporary relief to state governments, food assistance to the poor, and additional unemployment compensation. And all these provisions were set to end within a year or two.
Imagine, instead, that they had been written to remain in full effect as long as the unemployment rate was higher than, say, 7.5 percent, and then to phase out gradually below that threshold. In January 2009, the CBO would still have assigned a very low cost to such an approach for 2012, because its projections assumed a much lower jobless rate. (The budget office would have shown some modest cost to reflect the probability that unemployment would stay above the threshold.)
The CBO currently projects that the Recovery Act spending from these provisions (with their time-certain ending points) will amount to about $10 billion this year. If, instead, the tax cuts and spending had been in the form of automatic stabilizers that kept them going this year, they would amount to about 30 times that, delivering about $300 billion more in 2012 to support the economy. That would be enough to knock the jobless rate down by a full percentage point or more.
(In fairness, if the Recovery Act had remained in full force, Congress may not have enacted other temporary provisions. Nonetheless, the point still holds: If the stabilizers had been strengthened, the federal budget would be providing more support to the economy today.)
In this sense, the debate about whether the initial stimulus could and should have been larger misses an important point about its structure and duration. Linking it to the unemployment rate wouldn’t have affected its initial projected cost much, and therefore its acceptability to Congress may not have been compromised, but it would have helped much more today.
Automatic stabilizers allow for strong action in the face of two realities: that it’s difficult to predict what economic growth will be, and that Congress is slow to respond to economic fluctuations, especially as political polarization increases.
This is why the ideal approach is not to simply extend the payroll-tax holiday through the end of this year, as Congress is considering. Instead, lawmakers should keep it (and expanded jobless benefits) in effect as long as the unemployment rate remains elevated.
(Peter Orszag is vice chairman of global banking at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. The opinions expressed are his own.)
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