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The case for another stimulus

Three leading economists argue that fiscal expansion will be the best way for the economy to recover its lost potential and return to full employment.
Jimmy Martinez works at a Colorado National Guard construction site funded by federal stimulus funds on Oct. 1, 2010 in Lakewood, Colo.
Jimmy Martinez works at a Colorado National Guard construction site funded by federal stimulus funds on Oct. 1, 2010 in Lakewood, Colo.

Washington’s fever for deficit reduction seems to have finally broken.

But Congress’s ongoing allergy to fiscal stimulus may do lasting harm to an economy that’s still damaged by the Great Recession.

With millions still unemployed and businesses cautious about hiring, the economy is performing well below its potential, dampening growth projections and raising our long-term deficit.  Three economists believe that trend is likely to continue for years to come unless there’s a major change of course. And they argue that the most effective solution would be fiscal expansion—a mix of tax cuts and government spending that has become politically toxic on Capitol Hill. 

“The purported benefits of austerity would be achieved by its opposite,” said former Obama economic adviser Larry Summers on Wednesday, presenting a new paper for the Center on Budget and Policy Priorities. 

The big question looming over our sluggish recovery is just how the U.S. economy will remain in low gear, with too few jobs and too many people looking for work. “No amount of training will be enough if there are not enough jobs to fill,” Federal Reserve Chair Janet Yellen said in a speech this week. 

The Fed, however, has already reached the limits of what it can do to stimulate the economy: Interest rates remain at historic lows, but borrowing hasn’t ramped up enough and demand remains weak—what economists call a “liquidity trap.” And if we simply continue on our current course, those conditions could linger for far longer than we would like, depressing wages and pushing more people permanently out of the labor market. 

That’s why three economists—Summers, University of California-Berkeley’s Brad DeLong, and Johns Hopkins’ Laurence Ball—believe that the government needs to take a far more active role to intervene, namely through fiscal policy. 

“A sizable fiscal expansion could go a long way toward restoring full employment,” they write in the CBPP paper.

Typically, the concern is that major stimulus would risk overheating the economy, spurring on inflation and crowding out private investment. Those are some of the major arguments that Republicans rely on every time a new spending program is proposed, and the thinking that drives Paul Ryan’s austerity budget

But the unusual state of the economy right now would prevent that from happening, the paper argues: In a liquidity trap, fiscal stimulus would actually help increase private investment by raising future demand, spurring on economic growth that “is likely to reduce than increase the long-run debt burden.”

That would be a far more effective way to get back to full employment than skills training for jobs that simply aren’t there, Summers asserts. Despite the ongoing alarmism about America’s “skills gap,” the main reason that business are holding back from hiring is because “there is a lot of uncertainty about future orders and about future demand,” he says. 

The consequences of inaction are serious. We’ve lost $800 billion in capacity, and our potential output is now about 7% lower than had been predicted before the recession, notes Summers, citing a Federal Reserve Board working paper co-authored by Dave Reifschneider, William Wascher, and David Wilcox. And much of that output gap could continue permanently without further action.

Summers’ preferred approach would be major infrastructure spending, given the pressing need to make such fixes and ongoing unemployment in the construction industry. Neglecting infrastructure, he adds, is “pushing a debt forward to the next generation, just as surely as borrowing money with something called bonds.”

Congress, instead, has spent the last three years about just how much austerity to impose upon the economy, only reversing spending cuts by a fraction in the last budget. Even Summers himself has previously expressed caution on spending: When he was part of the Obama transition team in 2008, he infamously rejected the idea of proposing a $1.2 or $1.8 trillion stimulus to President Obama as unrealistic, according to The New Republic's Noam Schneider. 

As for investing in infrastructure? After a glimmer of a breakthrough in late 2013, Congress is gridlocked yet again on a infrastructure bill to fix its ports and waterways. In fact, it hasn’t passed a water infrastructure bill in seven years.

Update: Kelly Friendly, a spokeswoman for Summers, says that "he was always for most fiscal stimulus politically possible" during his time on the Obama transition team and in the administration.