Five Prescriptions to Heal Economy: Laurence Kotlikoff

(Corrects number of companies in 14th paragraph.)

Sept. 28 (Bloomberg) -- Desperate times call for creative measures. We’re in desperate times, but we’ve had little creative thinking from the Obama administration on how to fix the economy.

According to Ron Suskind’s new book, “Confidence Men,” Lawrence Summers, formerly the president’s chief economist, was concerned more with controlling than developing policy. No surprise. Hiring Summers was a huge mistake. But he’s gone, and the current economics team is free to think outside of Summers’s narrow, politically calculated box.

The president’s new-yet-familiar jobs bill entails more spending and more tax cuts, neither of which is affordable absent new revenue. The president wants the rich to cover the bill’s cost. House Republicans are saying no, dooming the bill to political oblivion.

What about printing more money? The Fed has already printed $1.8 trillion since September 2007. This exceeds by a factor of two all the money the Fed had printed since its creation in 1913. Printing even more money can’t be the answer.

The situation isn’t hopeless. I see five things policy makers can do to get the economy going. All involve ways to overcome what we economists call “coordination failures.”

1. Stop paying interest on bank reserves.

The Fed has effectively been bribing banks not to lend to businesses all the extra money it has been printing. It does so by paying interest on the excess reserves they hold on account at the central bank. We’re talking lots of excess reserves: $1.5 trillion today versus $2 billion in 2007.

Banks don’t want to lend the money because they worry about the state of the economy. But if the Fed encouraged banks to lend en masse to companies that would be able to repay in a normal economy, their collective lending would help produce that normal economy.

So here’s one no-brainer. Have the Fed stop paying interest on reserves and start encouraging the banks to make loans. Our bankers are supposed to know the best and brightest companies in which to invest. Why else would we tolerate the terrible financial risk to which they expose our country?

Let’s say, “Bankers, you’re on. Find $1.6 trillion in the best investment projects you can -- projects based in the U.S. that involve hiring lots of Americans -- and lend your excess reserves.”

The move would create inflation risk by increasing the amount of money (cash and demand deposits) directly held by the public. But the new output generated by the loans would help keep prices in check. And if prices rise, the Fed can quickly reverse the measures it has been taking to pump money into the economy.

2. Get workers to invest in jobs.

About 14 million Americans are out of work. If we cut that figure by 6 million, we’d have 5 percent unemployment -- close to the rate in good times.

Our country has some 120,000 companies that individually employ 100 or more workers and collectively employ about 80 million workers. President Barack Obama could call on the workers and shareholders in these companies to voluntarily hire 7.5 percent more workers and do everything possible to maintain the higher level of employment going forward.

How, one might ask, would all the new workers be paid? Existing employees could agree to a 7.5 percent wage cut in exchange for immediately vested shares of their companies’ stock of equal value. If their companies aren’t incorporated, company owners could segregate a portion of the company’s profits to be paid, over time, to those workers taking the immediate pay cut. This plan asks workers to finance the new hiring, but makes company owners ultimately pay the bill.

This is very different from asking one company to increase employment alone. Under this policy, all large companies will know that all other large companies are hiring. Hence, they’ll know that there will be a bigger demand for the additional goods and services their new employees will produce.

In 2008, German workers and employers voluntarily adopted national job-saving measures, and the German economy is now the envy of the world.

3. Encourage corporate America to invest.

Large companies are purportedly sitting on roughly $2 trillion in cash. They are waiting for the economy to improve before they invest, but it won’t improve until they all do so. The president can help resolve this problem by assembling in one room the CEOs of the largest 1,000 U.S. companies and getting them to collectively pledge to double their U.S. investment over the next three years. If they all invested simultaneously, they would immediately create much of the demand needed to make their investments worthwhile.

4. Get prices and wages unstuck.

Some prices and wages are set too high, thereby damping demand for output and for the workers needed to produce it. This is the standard sticky wage and price explanation for our economic malaise offered by Keynesian economists such as Paul Krugman and James Galbraith. I think there are fewer markets suffering from this problem than Krugman and Galbraith do, but there are enough such markets to make the case for government intervention. Indeed, the president should put these economists in charge of identifying the markets suffering from this problem and helping their participants set market-clearing prices and wages.

One example is the market for construction workers. A 1931 law called the Davis-Bacon Act effectively requires contractors using federal money to pay union wages. If the act were suspended or repealed, federal spending on much-needed infrastructure projects could create a lot more jobs.

5. Achieve fiscal sustainability

The government’s huge official debt and enormous future Social Security and health-care liabilities raise the gigantic question: Who will pay these bills? In such an environment, companies aren’t going to invest and households aren’t going to spend. I’ve been advocating reforms that would radically simplify our tax system, fix Social Security and health care, and put our government finances on a sustainable course. What’s more, these plans, called the Purple Plans, should strongly appeal to both blue Americans, like President Obama, and red Americans, like Paul Ryan.

Our economy is very sick, and its appointed doctors haven’t found a cure. It’s time for new doctors with new medicine. The above five prescriptions deal with the economy’s five most severe conditions. If these prescriptions are filled, the economy won’t just get back on its feet. It will start running the marathon.

(Laurence Kotlikoff, a professor of economics at Boston University, is a Bloomberg View columnist. The opinions expressed are his own.)

To contact the writer of this article: Laurence Kotlikoff at

To contact the editor responsible for this article: Mark Whitehouse at

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