The Journal and the Recovery

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.

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20 Responses to “The Journal and the Recovery”


  1. 1 Luis H Arroyo August 1, 2011 at 1:34 am

    Proud of being the first to congratulate you.

    However, recently I have a doubt. The external deficit is not a barrier to monetaria policy? I´m thinking in the Rajan argument: loose monetary policy plus fixed exange rate in China and others countries don´t they sterilized a lot internal impulse of money?
    Thanks

  2. 2 Craig August 1, 2011 at 3:46 am

    “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 … So most of the increase in federal spending relative to GDP was already in place by the time Mr. Obama took office”

    Your conclusion does not necessarily follow your statistics. Your statistics say that in the quarter before Obama took office, spending (per GDP) was significantly lower than in the quarter after Obama took office. If you’d included a line like “given the lags in fiscal policy,” you might have avoided this tendentious comment.

    “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.”

    Again, your numbers do not support this statement. If federal spending were constant, it would take a 20% reduction in GDP to account for the noted increase in per-GDP spending.

  3. 3 João Marcus Marinho Nunes August 1, 2011 at 9:39 am

    Reagan, like Elvis, “is alive”! To the WSJ he´s a hero, to Krugman he´s the “devil incarnate” (see his recent Raegan bashing posts). I think, in quasi monetarist terms, as I showed in a recent post, that the main difference between the recovery from the 1981/82 recession and the 2007/09 one is that in the former nominal spending was “vibrant”.

  4. 4 Luis H Arroyo August 1, 2011 at 10:12 am

    Ok, it was vibrant, but not necessary for monetary reason; I remember that it was a period of strong optimism, the dollar at ceiling, suddenly America was in the vibrant mood; I can not believe that it was only the expansion of money the vibrant NGDP. There were many other reasons, many changes comparing to the previuos stagnated situation. For example the liberation of so many markets.

  5. 5 Benjamin Cole August 1, 2011 at 10:52 am

    Superb post.

  6. 6 Benjamin Cole August 1, 2011 at 10:53 am

    BTW, if you write about Japan, please refer to “Mr. Bernanke-san.”

  7. 7 David Glasner August 1, 2011 at 12:10 pm

    Luis, Thanks. I don’t think that I understand your concern. China has had fixed exchange rate and has been running a balance of payments surplus, accumulating reserves. They have been sterilizing inflows rather than allowing domestic prices and wages to rise to maintain external equilibrium. Perhaps you can clarify for me.

    Craig, You are right that I was a bit too hasty in drawing conclusions. Real federal expenditures did increase by almost 9% in the second quarter of 2009 accounting for an almost 2% increase in the share of federal spending in GDP that quarter. The biggest real increase in real federal spending under Reagan was about 3.7% in the fourth quarter of 1982. If federal spending had only increased by 3.7% in the second quarter of 2009, the share of federal spending would have been somewhere between 24 and 24.4% depending on whether one assumes a multiplier of .8 or 2, which is the range of empirical estimates of the government spending multiplier. Even with that adjustment, I think that my basic criticism of the Journal still stands.

    Marcus, You are totally correct. What is more, as I pointed out in an earlier posting, in the Reagan Administration, the WSJ in 1984 began criticizing Volcker for keeping money too tight, starving the economy of needed liquidity, even though the CPI was rising then at over 3% a year. In those days, with a favorite sound money Republican occupying the White House, the Journal had a much more nonchalant attitude toward inflation than it does now with a currency debasing Democrat under whom the CPI has increased at a 1-2% rate.

    Luis, Clearly there was an improvement in the general business outlook in those days, so one does not want to minimize other factors. The point is that monetary policy was not obsessively preoccupied with reducing the rate of inflation even though it was then at a rate that today’s inflation hawks would regard as catastrophic.

    Benjamin, Thanks. I always pay attention to your advice even if I don’t necessarily follow it.

  8. 8 Lorenzo from Oz August 1, 2011 at 2:31 pm

    The Journal tells a good story, but the actual data tell a different one. Great line in a very clear and informative post, thank you.

  9. 9 João Marcus Marinho Nunes August 1, 2011 at 2:44 pm

    On the “improvement in the business outlook” there is this story (maybe only half myth): In his first cabinet meeting in early 1981, amidst the high interest rates and inflation and unemployment climbing to over 10%, Reagan had “only” two things to say:
    1. I hate the Soviet Union
    2. I hate big government
    So guys, you´ve got your work cut-out for you!
    The rest is history. Goes to show the power of being clear and succint!

  10. 10 Luis H Arroyo August 2, 2011 at 12:56 am

    Well I was refering to Rajan´s Theory that the low level of the Yuang jointly with the loose monetary policy of the FED produced the huge external deficit that was converted in huge reseve for China and so high inflows of capital in the US´s banks.
    In fact if comercial partners maintain a low exchange rate constantly the increases of AD would be deviate toward imports, as it was the case in 2003-07.
    What I don´t understand is why U.S. economists do not pay more attention to deviations of monetary impulses to the imports.
    US economy is not a closed economy.

  11. 11 gabe August 2, 2011 at 8:35 am

    Then he was shot by a family friend of the ex-head of the CIA.

    Then the government grew quickly and the deficits exploded. Payroll tax revenue grew more than income taxes revenue shrunk. and the ex-cia head became president.

  12. 12 David Glasner August 2, 2011 at 8:59 am

    Luis, I agree (even though Scott Sumner disagrees) that China’s policy of accumulating dollars was important in driving real interests rates down in the early and middle years of the previous decade (aka the worldwide savings glut). The problem was not the fixed exchange rate; the problem was that China sterilized the dollar inflow instead of allowing the inflow to drive up Chinese wages and prices, thereby inducing an expansion of Chinese non-tradable-goods sector and increasing the Chinese demand for imports. The US had a similar problem in the relatively stagnant in 1950s, when all of its major trading partners had fixed exchange rates at undervalued levels and chose to sterilize inflows, which they could do with the wartime capital controls still in place, while keeping their exchange rates against the dollar fixed. As a result there was a persistent loss of gold by the US and with unemployment chronically higher in the US than in Japan and Europe. The Kennedy administration finally forced the Fed to speed up monetary growth and force the other countries to accept even more dollars or revalue their currencies, as Germany eventually did. Then the Vietnam war led to so much US inflation and so large an accumulation of dollars that Bretton Woods gradually come apart. The only way to punish the Chinese for their bad behavior is for the US to make it increasingly costly for them to accumulate dollars by inflating. US inflation would also make it easier for China to revalue their currency without suffering domestic deflation as Japan did in the 1990s when they were coerced into allowing the yen to appreciate against the dollar.

  13. 13 Luis H Arroyo August 2, 2011 at 10:41 am

    yes, all right, I agree 100%.

  14. 14 Robert Fitzroy August 2, 2011 at 2:54 pm

    In a recession, GDP growth is small or negative, while government spending is likely to either not change or increase. It then seems pointless to consider government spending as a percentage of GDP, since it will always appear that the government is spending a lot more.

  15. 15 João Marcus Marinho Nunes August 2, 2011 at 3:40 pm

    Government grew and than shrunk when Congress finally got its act together in 1986. Tellingly you don´t mention the fate of the Soviet Union. The end of the Cold War was certainly “technologically liberating”. Nobody is “all good” or “all bad”, but Reagan certainly presided over important transformations.

  16. 16 David Glasner August 3, 2011 at 7:37 pm

    Robert, That was the point I was making, government spending tends to go up during a recession because of things like unemployment insurance and food stamps even without any deliberate countercyclical policy; taxes tend to tend to fall even faster than income falls, so deficit spending tends to rise really fast. Only a small part of the deficits and the accumulation of debt since the downturn began is attributable to any deliberate policy choices made by Obama


  1. 1 Skepticlawyer » Postmodern Conservatism Trackback on August 11, 2011 at 5:01 am
  2. 2 TheMoneyIllusion » Postmodern Conservatism Trackback on August 11, 2011 at 6:50 am
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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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