In his final speech as Fed Chair, Ben Bernanke identifies the #1 thing that’s caused the economy to be so slow: not enough government spending. He specifically calls fiscal policy “excessively tight.”
To this list of reasons for the slow recovery–the effects of the financial crisis, problems in the housing and mortgage markets, weaker-than-expected productivity growth, and events in Europe and elsewhere–I would add one more significant factor–namely, fiscal policy. Federal fiscal policy was expansionary in 2009 and 2010. Since that time, however, federal fiscal policy has turned quite restrictive; according to the Congressional Budget Office, tax increases and spending cuts likely lowered output growth in 2013 by as much as 1-1/2 percentage points. In addition, throughout much of the recovery, state and local government budgets have been highly contractionary, reflecting their adjustment to sharply declining tax revenues. To illustrate the extent of fiscal tightness, at the current point in the recovery from the 2001 recession, employment at all levels of government had increased by nearly 600,000 workers; in contrast, in the current recovery, government employment has declined by more than 700,000 jobs, a net difference of more than 1.3 million jobs. There have been corresponding cuts in government investment, in infrastructure for example, as well as increases in taxes and reductions in transfers.
Although long-term fiscal sustainability is a critical objective, excessively tight near-term fiscal policies have likely been counterproductive. Most importantly, with fiscal and monetary policy working in opposite directions, the recovery is weaker than it otherwise would be. But the current policy mix is particularly problematic when interest rates are very low, as is the case today. Monetary policy has less room to manoeuvre when interest rates are close to zero, while expansionary fiscal policy is likely both more effective and less costly in terms of increased debt burden when interest rates are pinned at low levels. A more balanced policy mix might also avoid some of the costs of very low interest rates, such as potential risks to financial stability, without sacrificing jobs and growth.
This of course flies right in the face of the GOP argument that government spending is way too high and that fiscal policy is too loose.
But the data clearly bears Bernanke out.
This chart from the Cleveland Fed shows how the trajectory of spending is so much lower than it has been in previous recoveries.
And this chart from Calculated Risk shows how government employment is on a much worse trajectory under Obama than it was under past Presidents.
So yes, Bernanke is spot on. Government spending has been very tight, and it’s holding back the recovery.
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