What will it take?
On the op-ed page of today’s New York Times, Peter A. Diamond explains why he’s withdrawing as a nominee to the Fed. A professor of economics at M.I.T. who won the Nobel Prize for his work on unemployment and the labor market, Diamond has been told by Republican senators that he isn’t qualified. In March Senator Richard Shelby of Alabama, the ranking Republican on the Senate Banking Committee, wondered aloud why President Obama would even consider nominating someone with Diamond’s background: “Does Dr. Diamond have any experience in conducting monetary policy? No. His academic work has been on pensions and labor market theory.” In his op-ed Diamond says Senator Shelby’s criticism reflects a “fundamental misunderstanding: a failure to recognize that analysis of unemployment is crucial to conducting monetary policy.”
[U]nderstanding the labor market — and the process by which workers and jobs come together and separate — is critical to devising an effective monetary policy. The financial crisis has led to continuing high unemployment. The Fed has to properly assess the nature of that unemployment to be able to lower it as much as possible while avoiding inflation. If much of the unemployment is related to the business cycle — caused by a lack of adequate demand — the Fed can act to reduce it without touching off inflation. If instead the unemployment is primarily structural — caused by mismatches between the skills that companies need and the skills that workers have — aggressive Fed action to reduce it could be misguided.
In my Nobel acceptance speech in December, I discussed in detail the patterns of hiring in the American economy, and concluded that structural unemployment and issues of mismatch were not important in the slow recovery we have been experiencing, and thus not a reason to stop an accommodative monetary policy…
If structural unemployment isn’t a good argument against accomodative monetary policy, it isn’t a good argument against stimulus spending either. Does anyone doubt that if Professor Diamond had reached the opposite conclusion, no one in the GOP would have questioned his competence to be a governor of the Fed? (There are seven governors, by the way, so there’s no reason any one of them has to be an expert about every problem the Fed must consider.)
Diamond’s work both qualifies and confirms a theory the Republicans have been attacking for over three decades — the Keynsian theory that there’s a positive correlation between total employment and aggregate demand. According to this theory, so long as there’s inadequate demand, neither monetary easing nor stimulative spending will cause inflation. If companies aren’t hiring because no one’s buying enough of their products – rather than because they can’t find workers able to do the jobs they need done — then the government can help by injecting more money into the system: more money will mean more demand and more employment, not higher inflation. Only when the economy is already operating at full capacity could such intervention cause inflation, and we are nowhere near full capacity now. More than 14 million Americans are currently unemployed, and millions more are underemployed.
Unemployment, then, and not public debt, is our most urgent economic problem. The priority of the unemployment problem is not only chronological (we worry that the government will go broke later; we see that people are out of work now); it’s also functional. There’s a good reason to think that doing whatever it takes to get unemployed Americans back to work will improve the government’s balance sheet, but there’s no good reason to think that doing whatever it takes to cut the deficit will help get the unemployed back to work. Never mind what Paul Ryan and the Wall Street Journal say: most investors care more about demand than about debt-to-GDP ratios.
In an excellent piece in the New Republic, Dean Baker argues that if the government doesn’t start doing more soon, we may be headed toward a second Great Depression after all. If this were only a national slump, then we might make up the shortfall in domestic demand by increasing exports (in which case we’d want more inflation, not less); but, as Baker notes, many of our trading partners are in even worse shape than we are. That leaves U.S. consumers or the federal government. As Baker writes:
Demand must come from some discrete source and it is very difficult to see where that might be if the country continues on a path of deficit reduction. To see why this is the case, first note that nearly 70 percent of demand in our economy is from consumption, but consumption has been growing slowly for two reasons. The first is that the economy has been creating few jobs. Furthermore, in a weak labor market workers do not have the bargaining power to push up their wages. The slow growth in jobs and stagnant wages mean that most families, who get nearly all their income from working, are seeing little growth in income. Slow growth in income means slow growth in consumption. [...]
[T]his leaves the government as the only remaining candidate for boosting the economy. But additional stimulus is not even on the agenda in Washington. Instead, we are seeing cutbacks at all levels of government. These cutbacks led to a loss of 29,000 jobs in May.
Baker points out that it wasn’t the New Deal but World War II that finally pulled the U.S. out of the Depression. During the war, “deficits peaked at more than 25 percent of GDP. This would be the equivalent, in today’s economy, of running annual deficits of $4 trillion.”
There was no economic reason that the government could not have spent on this scale in 1931, as opposed to 1941; the obstacles were political. Then, as now, politicians in Washington were obsessed with the budget deficit. They never would have countenanced such spending, apart from the threat to the nation posed by Hitler and the Axis powers.
What would it take today to get our politicians to stop spending all their time worrying about the government’s long-term solvency and to start worrying about the people who have been out of work for years and are running out of unemployment insurance and savings? It’s hard to take seriously the GOP leadership’s unctuous expressions of solicitude for future generations burdened by our fiscal profligacy when that same leadership demonstrates so little interest in the plight of Americans who are suffering now: the jobless, the homeless, the uninsured. Politicians can’t protect future generations by allowing the immiseration of this one. Solidarity, too, starts at home — with our neighbors, not their grandchildren.