In an editorial in its weekend edition, The Wall Street Journal, picking up where editorial writer Stephen Moore left off five weeks earlier in his piece touting a report by the Republican staff of the Joint Economic Committee, compares the powerful 1983-84 recovery from the 1981-82 recession with the anemic recovery since 2009 from the 2007-09 downturn. And guess what? The Journal finds the present recovery wanting.
No surprise there. Everyone knows that this recovery is feeble and that, in a very real sense, the Little Depression is ongoing. But the Journal, of course, wants to teach us a deeper lesson by comparing these two recoveries. The 1983-84 recovery was presided over by none other than the Journal’s hero, Ronald Reagan, in the full bloom of supply-side economics while the current recovery is the product of the detested doctrines of Keynesian economics embraced by the misguided Barack Obama.
This tale of two recoveries is an object lesson in economic policy. Taking office in 2009, President Obama embarked on one of the greatest reflation bets in history. He deployed the entire arsenal of neo-Keynesian policies to lift domestic demand, much as former White House economist Larry Summers still instructs at Harvard and most of the media still recommend.
So Congress deployed nearly a $1 trillion in stimulus, plus a battalion of temporary and targeted programs: cash for clunkers, cash for caulkers, tax credits for home buyers, 99 weeks of jobless benefits, “clean energy” grants, subsidies to states, and so much more. We were told that every $1 of this spending would conjure $1.50 in new economic output. The Federal Reserve has also more than cooperated by keeping interest rates near-zero for 31 months.
The Journal tells a good story, but the actual data tell a different one. The revised national income accounts data show that measured as a percentage of GDP, federal spending increased from 20.6 percent of GDP in the fourth quarter of 2007 when the downturn began to 25.4 percent of GDP in the second quarter of 2009 less than six months after Mr. Obama took office. Since then federal spending has held steady at about 25.5% of GDP. So most of the increase in federal spending relative to GDP was already in place by the time Mr. Obama took office, reflecting not a significant amount of new spending but rather the contraction of the economy. A relatively constant amount of spending increases as a share of GDP when GDP shrinks.
[Added 8/1/11 8:35PM. I should acknowledge that I overstated my caee here, as one of my commenters noted below. Federal spending did increase by almost 9% in real terms in the second quarter of 2009. GDP in the second quarter was just about flat, so it was the increse in spending that accounted for the increasing share of federal spending in GDP. Of course, without increased federal spending, GDP would likely have been even less than it was. In addition, since real federal spending during the 1981-82 recession was increasing under Reagan, it is plausible to assume that a substantial portion of the increase in federal spending in the second quarter of 2009 would have taken place even without Obama's stimulus program. So the correct statement is that even without Obama's Keynesian fiscal policy, the share of federal spending in GDP would have risen to between 24 and 24.5% rather than 25.5%.]
The patterns in the 1981-82 recession and the 1983-84 recovery are instructive in both their similarities and their differences. In the third quarter of the 1981, the last quarter before the downturn, federal spending as a share of GDP was 21.6%. When the downturn hit bottom in the fourth quarter of 1982, federal spending as a percentage of GDP was 24.1%. If the economy had continued to contract, federal spending relative to GDP would undoubtedly have continued to increase. When the economy did begin to expand, federal spending relative to GDP declined only slightly under President Reagan, staying over 22% until the last year of his second term, while tax revenues actually declined relative GDP, going down from 19.9% to just over 18%, where they stayed for most of his two terms.
In the 1981-82 recession, the decline in real GDP was about 2.7%; in the 2007-09 downturn, the decline was about 5.1%, nearly twice as much. In 1981-82 spending as a share of GDP increased about 2.5%, in 2007-09 federal spending relative to GDP increased about 5%, twice as much. So the Journal has it almost exactly backwards; the rise in federal spending since the downturn in 2007 reflects, for the most part, the depth of the downturn. It was not, as the Journal bizarrely alleges, a reflation bet made by Obama, much less “one of the greatest in history.”
So how does the Journal explain the exceptionally slow pace of this recovery? The Obama administration has frightened businesses and consumers.
An economy recovering from financial duress [sic] needs incentives to invest again, not threats of higher taxes. It needs encouragement to rebuild [sic] animal spirits, not rants against “millionaires and billionaires” and banker baiting. It needs careful monetary management, not endless easing that leads to commodity bubbles and $4 gasoline.
Such an economy also needs consistent and restrained government policy, not the frenetic rewriting of the entire health-care (ObamaCare), financial (Dodd-Frank), and energy (29 major EPA rule-makings) industries.
This is beyond pathetic. Profits and stock prices have recovered smartly since the economy hit bottom in the second quarter of 2009. What reason is there to suppose that, if businesses saw profitable opportunities to expand output and employment, they would forego those opportunities because they are afraid that the Obama administration would say unkind things about them? “Millionaires and billionaires” are always easy targets for politicians, and we have little reason to suspect that they are, as a class, easily intimidated or deterred from doing what they can to further enrich themselves by an occasional unkind remark by a politician, even if he happens to be President of the United States. And it is simply preposterous to suppose that if businesses thought they could make more profit by increasing output and expanding employment than by streamlining their operations, that they would not choose to make the larger profit, whatever the politicians might be saying. Does the Journal believe that the business climate is now worse than it was in 1971-72, when Richard Nixon imposed wage and price controls on the entire US economy, railed against the obscene profits of oil companies, and coerced Arthur Burns to open the monetary spigots to fuel a short-lived boom, albeit long-enough lasting to ensure his landslide re-election?
In 1971-72, rapid monetary expansion was unnecessary for recovery, but effective in achieving the goal for which it was implemented. In 2011, however, though necessary for recovery, monetary expansion has, appearances to the contrary notwithstanding, not been implemented, banks having been induced by an interest rate almost double that on 6-month Treasury bills to hold all the newly created reserves idle in their accounts with the Fed.
The Journal accuses Obama’s economic advisers of being unable to explain the failure of their economic policy advice. Perhaps they are. But some of us, especially Scott Sumner and, before his untimely passing a year ago, Earl Thompson, have been arguing all along that it was tight monetary policy that got us into this mess, and that monetary policy, despite appearances, had remained tight making recovery impossible. The malign effects of paying interest on reserves were identified almost immediately, and warnings that the policy would undermine the effectiveness of quantitative easing were issued from the get-go. Everything that has happened since has confirmed the validity and prescience of the initial analysis of the downturn and of the warnings about how paying interest on reserves would undercut monetary policy to promote recovery.
The Journal would do well to consider the possibility that there may be other explanations for the Little Depression of the past three years than the simplistic “us vs.them,” “supply-side vs. Keynesian” view of the world seemingly governing the pronouncements of its editorial page. Sophomoric outbursts like the one in last weekend’s edition bring no credit to a once venerable journalistic enterprise.