The Great Debate© is presented by Econintersect.com to expand our understanding of various topics of interest. In this Great Debate©, the topic is whether administration policies are dominant factors in the course of recovery. In a Wall Street Journal Op-Ed article, Michael Boskin, professor of economics at Stanford University, a senior fellow at the Hoover Institution and chair of the Council of Economic Advisers under President George H.W. Bush, insinuates that the policies of the current administration are responsible for producing a weak economic recovery.
Guest author Paul Kasriel counters that there are many causes for the weak recovery that Mr. Boskin misses. For one important example, the collapse of credit in this recession is much more severe than the recessions Boskin chose for comparison. Kasriel is Director of Economic Research at Northern Trust Global Economic Research in Chicago. He received the 2006 Lawrence R. Klein Award for Blue Chip Forecasting Accuracy in 2006. Mr Kasriel’s blog is The Econtrarian.
Summer of Economic Discontent
The Obama administration’s “summer of recovery” has morphed into a summer of economic discontent amid anxiety over the weakening economy. The greater than 4% growth and less than 8% unemployment envisioned by the president’s economic team are nowhere to be seen. Almost everything that is supposed to be up—the economic growth rate, the stock market, bond yields—is down. And almost everything that is supposed to be down—unemployment-insurance claims, new mortgage delinquencies—is up.
Sometimes a weak early recovery gathers strength after a year or so, as in 2003 when the second round of the Bush tax cuts helped double growth to 3.8% from 1.9%. But there are serious headwinds to stronger growth: household deleveraging, unresolved toxic assets, and most government economic policies headed in the wrong direction. While the base case outlook is still slow recovery, a double-dip recession or a Japanese-style lost decade is more plausible than a few months ago. This explains why Federal Reserve Chairman Ben Bernanke felt compelled last week to reiterate that the Fed will use more of its (in my view, weak) ammunition should the economy falter further.
How bad is it? In the data for the last few weeks and months, real personal disposable income was flat; core capital goods orders, a precursor of business capital spending, declined 8%; new home sales fell 12.4%, existing sales 27%, despite record low mortgage rates; single-family housing starts declined 4.2%; building permits, foreshadowing future construction, fell 1.2%; initial jobless claims spiked to over 500,000, leading forecasters to expect at best meager short-term private-sector job growth; the Kansas City, Philadelphia and New York Fed manufacturing indexes fell; and the trade deficit increased, as exports fell and imports rose.
These weak backward-looking data were accompanied by big downdrafts in forward-looking financial markets. The Dow Jones Industrial Average lost over 4% and the tech-heavy Nasdaq over 6% in August—partly retraced yesterday—and the 10-year U.S. bond yield, at 2.47%, was back to its lows of March 2009. Real GDP growth slowed from 3.7% in the first quarter to just 1.6% last quarter.
Worse yet, much of the growth in the first half of 2010 was due to inventory-rebuilding; real final sales grew at only about 1%. Consumers are cautious, saving and paying down debt. The surge in government spending is abating. Global trade, dependent on growth abroad, is slowing: Japan is stalled, China slowing, and despite Germany’s strong quarter, eurozone growth is projected to be only half America’s modest rate through 2011.
The one bright spot has been the rebound in business capital spending. Businesses are flush with cash and profits have been solid. But the weak core durable goods report, the manufacturing downshift, and continued uncertainty about the economy and the Obama administration’s economic policy have many forecasters reducing capital expenditure projections.
The sluggish growth is particularly disconcerting compared to the usual strong growth following deep recessions. The chart nearby shows the average real growth that occurred in the first four and first 12 quarters following the severe recessions of 1974-75 and 1981-82. Compared to the 6.2% first-year Ford recovery and 7.7% Reagan recovery, the Obama recovery at 3% is less than half speed. The unemployment rate would now be 8% or lower at those higher growth rates. If the Obama recovery continues at 3%, the president will be running for election in mid-2012 with a cumulative GDP recovery shortfall of 4.5% (relative to Ford) to 8.4% (relative to Reagan).
President Reagan won re-election with 49 states. President Ford came from 30 points back to lose narrowly to Jimmy Carter, and would have won easily were the election a few months later. What does this say about an Obama second term? With little discernible improvement in the economy from the president’s $862 billion in fiscal stimulus, citizens are revolting against the explosion of spending, deficits, higher taxes, government bailouts and economic micromanagement, and seem poised to put an exclamation mark on it in the November elections.
Not surprisingly, the left is frantically calling for a second “stimulus” and demanding tax hikes for the “rich”—a.k.a. our most productive citizens and small businesses. The rehashed ideas include such nonsense as massive infrastructure spending financed by a national infrastructure bank, an old Carter idea; yet more aid to the states; and even that worst of ideas, “general revenue sharing,” which would force citizens to pay future federal taxes to fund the debt used just to send revenue back to their states.
These ideas would do a lot more harm than good. To paraphrase Benjamin Franklin, we have the best economic system among the advanced economies, “if we can keep it.” That will require fundamental policy changes, not doubling down on the failed big government experiment of recent years.
The president and Congress would have to implement serious spending reductions, real entitlement reform focused on substantially slowing the growth of benefits per recipient, and no tax hikes. President Clinton made a major move back to the political center—to his own and the nation’s benefit—when Republicans won control of Congress in 1994. In partnership, they balanced the budget and reformed welfare. But recall, President Clinton’s major big-government initiative—HillaryCare—was defeated. For President Obama to get to a similar place after the midterm elections, he would have to partner in “repealing and replacing” his signature initiatives.
Michael Boskin’s Summer of Economic History Amnesia
by Paul L. Kasriel
In a September 2 op-ed commentary in the WSJ (“Summer of Economic Discontent”), Michael Boskin, former chairman of the President’s Council of Economic Advisers under Bush 41, compares the anemic current economic recovery with vibrant ones, such as the recovery that commenced in the first quarter of 1983, when Martin Feldstein was chairman of President Reagan’s Council of Economic Advisers. Mr. Boskin intimates that the reason the current economic recovery is so feeble is because of economic policies being pursued by the current presidential administration.
I am not here to argue for or against current policies, but merely to suggest that there is another or additional reason for the relative weakness in the first year of this current recovery, a reason that might also explain the relative weakness in the first year of the recovery that commenced in the second quarter of 1991. Mr. Boskin was the chairman of the President’s Council of Economic Advisers at the time of the 1991 economic recovery. I find it curious that he makes no reference to that recovery when critiquing the current recovery.
If you have been reading my recent commentaries, you probably have guessed the reason I am about to propose as playing a large role in restraining the pace of the current recovery – the unprecedented contraction in nominal and real bank credit in the post-WWII era. Mind you, I am not suggesting that this is the only factor – just an important one.
Chart 1 shows the year-over-year percent changes in real GDP and real bank credit one year after the final quarter of three recessions – Q4:1982, Q1:1991 and Q2:2009 (not yet designated so by the National Bureau of Economic Research). The relatively robust economic recovery in the four quarters ended 1983:4 of 7.7% growth in real GDP was accompanied by a 6.4% increase in real bank credit. The economic recovery that commenced in the second quarter of 1991 produced real GDP growth in its first year of only 2.6%. Notice though, real bank credit grew by only 1.4% in this recovery. In the first four quarters of the current economic recovery, real GDP is up 3.0%, not materially different than the 2.6% real GDP growth in the recovery commencing in the second quarter of 1991. In the first four quarters of the current recovery, real bank credit has contracted by 7.9%. The median four-quarter percentage chain in real bank credit from 1960:Q1 through Q2:2010 is 4.78%. So, the percentage change in real bank credit in the four quarters ended 1983:4 was above the median; the percentage changes in real bank credit in the four quarters ended 1992:Q1 and 2010:Q2 were below the median.
Obviously, there are other factors that explain the behavior of real GDP growth than just the behavior of real bank credit. If this were not the case, then the current economic recovery could not have achieved even the modest 3.0% growth in real GDP in its first four quarters. But the contraction in real bank credit in the first four quarters of this current economic recovery certainly could be considered a “headwind” to the recovery. I use the term “headwind” because this is exactly the term coined by Fed Chairman Greenspan with respect to weak credit creation to help explain the lackluster economic recovery that commenced in the second quarter of 1991. Do you remember some other terms that entered the economic lexicon during that period – terms such as “double-dip” and “jobless recovery”?
Speaking of jobless recoveries, I would like to refresh Mr. Boskin’s memory of the private-sector job creation during the first four quarters of the recovery that commenced in the second quarter of 1991 with job creation for comparable periods in other recoveries, starting with the 1961 recovery. These data are shown in Chart 2, which was created by my colleague, Asha Bangalore. Yes, private job creation so far in the current recovery pales in comparison to the average since 1961. But private job creation in the first four quarters of the current recovery exceeds that of the 1991 recovery, the one in which Michael Boskin was the president’s chief economic adviser.
Perhaps Mr. Boskin is not suffering so much from amnesia, as I have suggested, but rather is experiencing an episode of déjà vu. He intimates that if current economic trends continue, President Obama will have a difficult time being elected to second term in 2012. Yes, just as President George Herbert Walker Bush was unable to win a second term in 1992, which terminated Mr. Boskin’s tenure as chairman of the President’s Council of Economic Advisers.
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