The New New Deal Page 7
Some economists thought “monetary stimulus” from Federal Reserve interest rate cuts would be enough to reverse this particular slump. Some conservatives opposed any new spending that would make the government a bigger player in the economy. And some deficit hawks fretted about further increases in the federal debt; Keynes had prescribed fiscal expansion during emergencies, but also fiscal responsibility during non-emergencies, which hadn’t happened under Bush.
Still, the general question of whether fiscal stimulus could help create jobs and revive output in the short term wasn’t much of a question back then. The question was how to do it properly, a question Keynes had never fully answered.
Raising Keynes
Keynes wrote his masterpiece, The General Theory of Employment, Interest and Money, during the depths of the Depression.70 It’s full of revolutionary macroeconomic concepts, like the paradox of thrift, the marginal propensity to consume, and the Keynesian multiplier. But it’s mostly a book about depressions—how they happen, and how to prevent or end them. Summers thought it should have been titled A Specific Theory of Collapsing Employment, Interest and Money.71
Before the Great Depression, most economists believed markets were automatically self-correcting. They assumed all downturns would eventually create a virtuous cycle: cheaper prices would spur consumption, cheaper money would spur investment, and lower wages would spur hiring. It was an elegant theory, but after the crash of 1929, reality didn’t cooperate. President Hoover’s treasury secretary, Andrew Mellon, expressed the orthodoxy of the day when he described the Depression as a useful corrective to sloth and excess that would “purge the rottenness out of the system.” If you weren’t a Mellon, though, the Depression was pretty rotten.
Keynes saw recessions as simple failures of demand for goods and services, not as some kind of karmic retribution for moral turpitude. And he saw how a convulsive shock like Black Tuesday could create a vicious rather than virtuous cycle: lost income led to lost confidence, which led to hoarding of cash, which led to layoffs and cutbacks that left productive workers and equipment idle, which further depressed income as well as confidence, and so on down the drain. Part of the problem was a real deterioration of purchasing power. Workers without jobs couldn’t spend as much, even when prices were low, and businesses without customers couldn’t invest or hire as much, even when interest rates and wages were low. The other part of the problem was psychological, what Keynes dubbed “animal spirits.” Workers worried about losing their jobs and businesses worried about losing their customers would tighten their belts, too, perpetuating the paralyzing feedback loop. There’s a reason economic terms like “depression,” “panic,” “uncertainty,” and “demand” have psychological roots. Markets really can get jittery. The economy really is a confidence game.
Keynes concluded that the solution to both parts of the problem was an aggressive government effort to revive demand, an infusion of cash and confidence. Saving had always been considered a purely good thing, but Keynes saw that in a crisis what was needed was more spending. More saving would just deepen the crisis. (That’s the paradox of thrift.) And when consumers and businesses were too broke or too scared to spend, government would have to be the spender of last resort. Budget deficits had always been considered a purely bad thing, but Keynes saw that when the private sector hunkered down and demand dried up, the public sector needed to send more money into the economy than it took back in taxes. Once consumers started spending again, businesses would hire more workers and make new investments, and the virtuous cycle could begin anew.
Keynes wasn’t rejecting capitalism, just the laissez-faire assumption that a shattered economy could always heal itself. He wasn’t recommending a new car, just a new “magneto,” or ignition system, a jump-start for a stalled economic engine. And he wasn’t too fussy about how that magneto was designed, as long as it got cash to flow from the government to the people. He suggested the Treasury could even “fill old bottles with bank notes, bury them at suitable depths in disused coal mines,” then watch an inevitable money-mining boom create jobs and economic activity.
“It would, indeed, be more sensible to build houses and the like, but … the above would be better than nothing,” he wrote.
But not all magnetos are created equal. Burying cash was not an alluring option. After an epic real estate bust that left entire subdivisions vacant, “building houses and the like” didn’t seem so sensible, either.
So what was government to do? Traditionally, Republicans equated stimulus with tax cuts—and sure enough, the Bush White House, which would have prescribed tax cuts for a sore throat, was looking into new ones, while calling for a permanent extension of the original Bush tax cuts that were scheduled to expire in 2011. Generally, liberal Democrats preferred stimulus in the form of spending on liberal Democratic priorities—and true to form, Speaker Nancy Pelosi was pushing to cram extra cash into food stamps, public works, and renewable energy.
Summers, neither a Republican nor a liberal Democrat, did not think the question of how to stimulate the economy in the short term should be answered ideologically. He thought it should be answered correctly. At Brookings, he proposed a technocratic approach to Keynesian stimulus that has dominated the debate ever since. A stimulus package, he argued, should be timely, targeted, and temporary.
In other words, it should kick in fast enough to help cure the downturn; stimulus that isn’t timely can overheat an economy that’s already rebounding and unleash inflation. It should target the biggest economic bang for each buck; fortuitously, the struggling families who need it most are the families most likely to spend it quickly. (That’s what Keynes meant by a high marginal propensity to consume.) Finally, stimulus should spur short-term growth without unnecessarily expanding long-term deficits, which could boost interest rates, slow down growth, and defeat the whole purpose of the exercise. Romney’s $250 billion plan would have amounted to nearly 2 percent of GDP, but Summers, worried about red ink, suggested that politicians should think “two digits, not three,” and let the Fed do most of the work.
The allure of fiscal stimulus from Congress was its ability to pump dollars quickly into the pockets of consumers and the coffers of businesses, as opposed to monetary stimulus from the Fed, which would pump dollars into the vaults of banks that were reluctant to lend at a time when businesses were reluctant to borrow. But fiscal stimulus had a downside, too. It would only work if a bitterly divided political system could pass timely, targeted, and temporary legislation in a hurry.
“Poorly designed fiscal stimulus,” Summers wrote in a column that would be quoted frequently a year later, “can have worse side effects than the disease that is to be cured.”72
Stimulus, Round One
In January 2008, Hillary Clinton released her plan to juice the weakening economy. To Obama’s economists, it looked like a textbook example of poorly designed stimulus. The centerpiece was $25 billion to help low-income families with heating bills, a tenfold expansion of an existing program, an administrative nightmare that made Jeffrey Liebman, yet another Harvard professor on Obama’s team, wonder if Hillary had misplaced a decimal point. The money wouldn’t go out until the next winter, which didn’t seem timely at all. Austan Goolsbee, a thirty-eight-year-old Obama adviser from the University of Chicago who was new to presidential politics, was shocked by the economic malpractice. “A year later is not stimulus!” he kept saying.
Goolsbee, who would later advise Obama in the White House, and Liebman, who would become a deputy in his budget office, had cooked up Making Work Pay over a weekend. Now they had two days to finalize a plan for real short-term stimulus—the first dress rehearsal for the Recovery Act. “It was my only true all-nighter of the campaign,” Liebman recalls. “But we knew we were going to blow Clinton’s plan away. We just stuck to the basics—timely, targeted, and temporary.”
The three T’s were suddenly the quasi-official test of the stimulus strategies flying around Washington. And so
me strategies flunked.
Regardless of the merits, making the Bush tax cuts permanent would be the opposite of timely, targeted, and temporary. It wouldn’t take effect until 2011; it would help well-off families with low propensities to spend; and it would explode the deficit. Permanent corporate tax cuts, a key plank of the McCain and Romney plans, also batted 0-for-3. A new Brookings stimulus analysis titled “If, When, How” rated both strategies “ineffective or counterproductive,” while a Moody’s Economy.com analysis of how much growth various policies would produce per dollar—the Keynesian multiplier—scored both below 50 cents.73 The Brookings report was written by two Clinton administration economists—Jason Furman, a Summers protégé who was running the Hamilton Project, and Doug Elmendorf, another former Summers student—but the Moody’s author, Mark Zandi, was a McCain campaign adviser.
By contrast, policies benefiting lower-income families provided much more bang for the buck, because the poor can’t afford to hoard. Increases in food stamps earned the highest multiplier from Moody’s, adding $1.73 in output for each dollar in cost. Extending unemployment benefits, which normally expire after six months, came in second. Those strategies batted 3-for-3: The benefits would go out instantly, target families likely to spend, and fade once the economy improved. One-time tax rebates also got decent marks, but only if those 35 million low-income workers who didn’t pay income tax were eligible. Many Republicans saw refundable tax cuts as glorified welfare—the Wall Street Journal editorial page referred to the low-income recipients as “lucky duckies”—but a new CBO report noted that making rebates nonrefundable “substantially reduces the cost-effectiveness of the stimulus.”
Public works also had high bang for the buck, but economists didn’t think they were timely. Under Clinton, Summers had been a savage infrastructure critic, and while the new invest-in-America Larry was more sympathetic to moving dirt and pouring concrete, the old crunch-the-numbers Larry still doubted its value as stimulus. Peter Orszag’s CBO also dumped on infrastructure’s glacial pace in another little-noticed aside that would resurface a year later, noting that “public works involve long start-up lags,” and “even those that are ‘on the shelf’ generally cannot be undertaken quickly enough to provide timely stimulus.”
There was one more three-T idea: aid to states. As the downturn shriveled their revenues, state balanced budget requirements were poised to force austerity measures at the worst possible time, an “anti-stimulus” that would drain more money out of the economy. Bailing out cash-strapped states could provide a jolt of anti-anti-stimulus, preventing layoffs of public employees, cuts in services for the vulnerable, and tax hikes on everyone. But the politics were awful. Why would Congress want to help states close their fiscal gaps by expanding the nation’s? And why would a Democratic Congress want to help Republican governors fix their state deficits, so they could look virtuous while scolding Washington about national deficits? Senate majority leader Harry Reid of Nevada had little interest in bailing out scandal-ridden Nevada’s GOP governor Jim Gibbons, whose potential challengers included Reid’s son Rory, and Pelosi felt similarly disinclined to do favors for GOP governor Arnold Schwarzenegger of California.
But Obama’s economists focused on the three T’s. So their plan included state aid and unemployment benefits, while popular but slow infrastructure projects didn’t make the cut.74 The centerpiece was a refundable tax rebate for almost all workers, a one-time version of Making Work Pay. Overall, the plan cost $75 billion—two digits, not three—with a trigger to go to $120 billion if the economy didn’t rebound. It was somewhat bigger than Hillary’s plan, but the Times columnist and Nobel laureate economist Paul Krugman cautioned his liberal readers that it “tilted to the right” by including tax cuts and leaving out alternative energy: “I know that Mr. Obama’s supporters hate to hear this, but he really is less progressive than his rivals on matters of domestic policy.”75
Obama explained that he loved alternative energy. It just wasn’t the fastest stimulus. “That’s not going to deal with the immediate crisis,” he said. His campaign handouts were even more emphatic about three-T-only: “The goal should be to lessen the pain that would occur from an economy-wide slowdown, not to use economic hardship as a rationale for enacting an ideologically driven policy agenda.” Those words would resonate a year later, too.
But in early 2008, Obama was the only candidate with a stimulus plan that was all about stimulus. When the Washington Post’s Marcus graded the campaign proposals, Obama won easily with an A-minus.76 Clinton got a C-plus, McCain a D-plus.
“The moment for stimulus will be long past by Inauguration Day,” Marcus wrote, a line that wouldn’t resonate at all a year later. “But as a way of judging how candidates balance politics and policy … the proposals offer a revealing report card.”
The moment for stimulus had arrived. But it depended on a quick bipartisan deal, which seemed about as likely as a quick Middle East peace treaty.
Washington really was as polarized as the talking heads said it was. In Congress, almost every vote was a party-line vote. House redistricting had produced reliably Democratic and Republican seats, encouraging incumbents to pander to their bases, rewarding extremism while punishing cooperation. Members flew home every weekend and spent their spare time fund-raising during the week, so they no longer hung out in noncombat situations; Ray LaHood, an Illinois Republican who would become Obama’s transportation secretary, had organized bipartisan get-to-know-you retreats, but they were canceled for lack of interest. The rise of talk radio, cable blab shows, political blogs, and the twenty-four-hour news cycle only widened the divide, encouraging increasingly sensational attacks in much the same way SportsCenter encourages increasingly sensational dunks. Every day was election day, and in a zero-sum game, party discipline was paramount; if the blue team said the sky was blue, the red team called a point of order.
By 2008, Bush’s approval rating had collapsed, but he was staying the partisan course, starting the year by vetoing a Democratic expansion of health coverage for uninsured children even though it had some Republican support. Democrats weren’t in a compromising mood, either. They had taken back Congress in 2006 with a Bush-bashing message, and it’s tough to cut deals with someone you’ve portrayed as a heartless Neanderthal; it makes your base wonder how you could work with such a monster, and independent voters wonder if you exaggerated his monstrosity. Anyway, Speaker Pelosi, an organic-kale San Francisco liberal with a grating voice that made her sound like the nanny state come to life, was just as polarizing as the swaggering Texas cowboy in the White House. She was nails on the blackboard to Republicans, a screechy symbol of lefty extremism. Conservatives loathed her, and many of the congressional moderates who merely disliked her had been defeated in the Democratic wave.
But Pelosi, the daughter of an Italian American machine pol from blue-collar Baltimore, was much more pragmatic than her banshee-lefty reputation. Behind the scenes, she was a master vote counter and a surprisingly deft coalition builder. Her members were much more ideologically diverse than the House Republicans, so she had to keep business-friendly New Democrats and tight-fisted Blue Dog Democrats on her reservation. At times, she could be as intransigent as advertised—her no-compromise leadership helped kill Bush’s plan to privatize Social Security—but she came from an urban-boss tradition of cutting deals that got things done. As shrill a partisan as she was, it wasn’t her nature to sit on her hands to try to reap the political benefits of a recession on Bush’s watch. She was an activist. She liked to act.
For a change, Pelosi had negotiating partners willing to negotiate. Bush’s treasury secretary, former Goldman Sachs CEO Henry Paulson, was a moderate Republican who understood the art of the deal and badly wanted stimulus. And Pelosi’s counterpart, House minority leader John Boehner, usually followed the administration’s lead. Boehner was a conservative K Street Republican whose best friends were mostly corporate lobbyists—a self-made millionaire who got into politi
cs because he hated taxes and government interference with his plastics company.77 But he was a team player, an amiable Dean Martin type who spent most of his time chain-smoking Camel Extra Lights, drinking Merlot, and playing golf. After growing up in a home with eleven siblings and one bathroom, he was comfortable with compromise. He had tried to rein in the GOP’s fire-breathers while serving on Gingrich’s leadership team, and he had helped forge the No Child Left Behind deal.
So there was at least a chance for cooperation, especially since stimulus wouldn’t involve painful sacrifices. Politicians usually enjoy spending money and cutting taxes in election years.
On January 18, Bush visited a lawnmower factory to unveil a $150 billion stimulus plan, “a shot in the arm to keep a fundamentally strong economy healthy.” Obama complained that the plan’s nonrefundable tax rebates would do nothing for the working poor, but otherwise Paulson kept it relatively free of ideology; the Post’s Marcus gave it a B-minus. It quickly became the basis for bipartisan talks in the House’s Board of Education room, the tiny hideaway where the legendary speaker Sam Rayburn used to “educate” members who crossed him.
At first, the negotiations just highlighted the gulf between the parties. Pelosi suggested all kinds of spending programs for the needy, while Boehner wanted all kinds of tax breaks for businesses. Boehner groused that the goal wasn’t supposed to be redistributing income. Pelosi snapped that the goal was supposed to be preventing “your potential recession.” One Boehner aide scribbled his partisan view of the debate in his notes: “D caucus, Tax Receivers. R conference, Taxpayers.”