This recovery is stagnant. And if consumers hole up for the winter, the economy will be headed for a second dip as well.
The stall in the manufacturing sector, which had been counted on to get us moving, is an almost certain sign that garden-variety antirecession measures are not enough. This has at least three specific policy implications. The first is that a standard Federal Reserve Board easing will not work. Fed funds rates have been cut 13 times since mid-1990, and the discount rate five times. Fed funds are trading at 4.75%, and the discount rate is at 4.5%, an 18-year low. This may make the governors of the Fed and Chairman Alan Greenspan feel they are doing their job, but the fact is that this standard version of monetary ease is not enough. That's because the banking system is in a crisis. Ordinarily, a 4.75% fed-funds rate means a prime of 6.25%, but even after the most recent cut the prime is at 7.5%. That means that the Fed must do more to lower the rates at which real businesses borrow money. One possibility: pay interest on bank reserves. Another is to bring these key interest rates down even further. The Fed has to do what is necessary to make the money supply grow faster.
The second policy implication is that tax cuts won't work. Consumers have a voracious appetite for imported goods, which is why tax cuts that boost consumer spending largely on imports provide no lasting benefits. That is true for deficit-neutral tax cuts, such as middle-class tax relief, which don't provide much stimulus, anyway.
Third, the structural nature of this stall may require even stronger medicine than Fed easing can provide. If so, a sweeping program of public investment to rebuild the nation's crumbling infrastructure is a better choice than lower taxes. Yes, it could be a budget-buster, but the money would be spent in the U.S. Carefully structured, the dollars would end up in the private sector, generating jobs and incomes. Public investment yields benefits for the long term as well as for the short term. Studies show a clear link between an economy's infrastructure spending and its productivity, an area in which the U.S. is sadly lacking.