Austerity vs. Deficits: What Are The Facts? Part 2
In Part 1 of this series, I presented the theories supporting austerity and deficit policies along with the best empirical research on the subject. I also examined three cases: Greece, Spain, and the UK. In this part, I will look at the US situation and draw overall conclusions.
Late 2008: the US banking meltdown resulted in stock market losses to US citizens of more than $10 trillion. Couple that with losses in real estate values of more than $7 trillion, and suddenly, households felt a lot poorer than they did a year earlier – $17 trillion in capital losses against a 2008 GDP of only $14.2 trillion – a tough year!
The predictable result was a spending collapse triggering US job losses of 8.4 million in 2008 and 2009. As I have argued earlier, the key statistic for understanding how the US is doing now is the number of people employed in the private sector. What has happened since then? At the end of September 2010, total non-farm employment had made up only 613,000 of the 8.4 million jobs lost. And the monthlies are not trending upwards: in the July-September period, job losses occurred in all three months and totaled 218,000. Not promising.
The Stimulus Effects
The US Congress has passed only one employment stimulus bill – the $787 billion American Recovery and Reinvestment Act (ARRA). Table 1 gives the Congressional Budget Office’s (CBO) estimate of what effect this bill will have on employment.
Table 1. – ARRA Stimulus Effects
(job gains in millions)
The CBO concludes that ARRA will create anywhere between 2.9 and 7.7 million jobs. That means that without it, the unemployment rate would have ended up in the 11.5%-14.6% range.
As reported in Part 1, the IMF has done the most comprehensive research on the effects of stimulus packages. It concludes that a fiscal consolidation of 1% results in an increase of .3 percentage points in the unemployment rate. Applying that to the US situation, in the absence of the ARRA, the unemployment rate would have increased to 11.3% which is just below the lower CBO estimate.
Now, what would the “Austerity” supporters have us do? Hard to say. One of the problems with the Austerity position is that it has not been clearly articulated. The Economist reviewed its articulation in the Republicans’ A Pledge to America. It concluded:
In general, the wordy document contains much talk of restoring “fiscal discipline” and stopping “job-killing tax hikes”. Critics have pointed out that these goals are largely contradictory. Extending tax cuts, after all, will add to America’s fiscal woes.
But assume “austerity” means no stimulus package. Without it, the unemployment rate would be 11%+ rather than 9.6%. So the “Austerity argument is that $787 billion cutback in the government deficit would have made Americans confident enough to start spending again? This stretches credulity. And remember that with no stimulus, there would be another 2+ million out of work. They are most certainly not going to feel confident about the future, and further, with no pay check coming in, they will spend less.
Was ARRA Big Enough?
Let us go in a different direction. As can be seen from Table 2, $551 billion or 70% of the ARRA stimulus money has been paid out. Is it an adequate stimulus? Remember, 218,000 jobs were lost in the last three months.
Bernanke is talking about trying to help out. But all the Fed can do is buy financial paper: it cannot spend money to create jobs. And unfortunately, Congress is not prepared to enact another stimulus package.
Table 2. – Status of Recovery Act Funds (bil. US$)
|Category||Paid Out||Act Funds|
|Contracts, Grants, Loans||146||275|
Table 3 provides the IMF’s projections for the US economy. They are not promising. Unemployment no lower in 2011, and after that, who really knows?
Table 3. – IMF Projections for US
|Government Deficit (% GDP)||-6.7||-12.9||-11.1||-9.7||-6.7||-5.7|
Other Stimulus Policy Considerations
A growing number of countries want to keep the dollar strong so they will have an advantage in selling goods in the US market. They prop up the dollar by purchasing US dollars (non-interest bearing US government debt) and Treasury securities (interest-bearing US government debt).
China and Japan are the largest purchasers. Indeed, the central banks of China and Japan have bought more US debt than the Fed: The Fed currently holds $821 billion US government securities while the central banks of China and Japan hold $868 billion and $837 billion, respectively. And other nations, such as Brazil, are also active in exchange markets to keep the dollar strong.
A Brief Technical Aside
When the Fed buys Treasury debt, it is effectively “printing money” in the sense that it provides the Treasury with dollars to spend. Ceteris paribus, this expansion in the “global” dollar supply will weaken the dollar. Purchases of US dollars or other US government debt by the central banks of other countries has just the opposite effect – it absorbs dollars/debt available on the global markets and strengthens the dollar.
In earlier articles, I have pointed out that China and Japan’s dollar purchases have strengthened the dollar and have been responsible significant job losses in the US, particularly in manufacturing. Conversely, a weaker US dollar would generate significant job growth in the US. Every so often, Geithner talks to Chinese about “more flexible exchange rates” – he means a weaker dollar. The Chinese are stringing him along. They don’t want a weaker dollar, it would hurt their exports.
So another factor to consider in weighing the pros and cons of a new stimulus bill is its effect on the value of the dollar. To the extent that it causes the dollar to weaken, jobs will return to the US and reduce the unemployment rate.
What the US Needs
The ARRA stimulus package was not enough to end the recession, and it is running out. The US Congress should pass a new stimulus package. As Tom Friedman and others have been arguing for some time, the US should copy the Chinese and invest most of the money in the communications, transport and energy sectors. The engineers I talk to say there are plenty of projects ready to go in these sectors, provided the stimulus bill is focused on them (according to recovery.org, 60% of the ARRA jobs were generated via Department of Education grants and contracts).
There will be three benefits from this package:
- Communication, energy and transport improvements;
- New jobs resulting directly from the stimulus;
- New jobs resulting from a weaker dollar.
How large should the new stimulus package be? There are several considerations here.
- The package should generate enough jobs so the private sector is encouraged and starts hiring again. Let us assume the total job gain resulting from ARRA will be 3 million jobs. That would leave more than 5 million still out of work. A stimulus package half the size of ARRA ($393 billion) should generate 1.5 million jobs, and that should be enough to bring private sector job hiring back in.
- But is $393 billion enough to upgrade the US communication, energy and transport sectors? Probably not.
- And will an additional deficit of this size be enough to weaken the dollar significantly and bring jobs back to the US? Probably not. The amount has to be big enough so the countries trying to keep the dollar strong are unable/unwilling to buy enough dollars….
In light of these considerations, a new $750 billion spending bill is needed. That will probably be more than enough to get employment up (taxes can be raised if it shows signs of overheating the economy). Targeted spending at this level should make a significant contribution to US communication, energy, and transport needs. And such an amount might be more enough to weaken the dollar substantially.
Overall Conclusions on Austerity vs. Deficits
Not much was learned about the benefits of an austerity strategy. Both Greece and Spain were forced into austerity programs, and unemployment is projected to increase. The UK is coming out of the global recession, and in these circumstances, even Keynesians would argue for a reduction in the government deficit. There is no evidence the US economy is recovering yet. To generate jobs and for other reasons, a new stimulus bill is needed.
 The $700 billion Troubled Asset Relief Program (TARP) was not a stimulus package. Rather, it involved the buying and selling of financial paper to keep the US banking system from total collapse.
 “Will It Hurt? Macroeconomic Effects of Fiscal Consolidation”, Chapter 3 of the IMF’s October 2010 “World Economic Outlook”.