Chad Stone is chief economist at the Center on Budget and Policy Priorities.
Last week's disappointing jobs report for June showed that a strong labor market recovery remains elusive. Policymakers have the tools to boost economic growth and reduce the unemployment rate faster through more stimulative monetary and fiscal policies, but they are not using them. That makes no sense.
When the economy is performing well, deficit-financed government spending or tax cuts do little or nothing to boost economic activity in the short run, and the additional debt weighs on future growth. On the monetary side, an increase in the supply of money and credit that reduces interest rates would do little to increase real economic activity and would mainly generate inflationary pressures. In other words, the trade-off between current gains and future costs from fiscal or monetary stimulus would tilt heavily toward the cost side.
The situation, however, is very different when the economy is in a slump, as it is now, with substantial excess unemployment and idle productive capacity. There is tremendous economic waste and human hardship in an economy that's operating well below full capacity. The goods and services that are not produced, the wages and business income that are not earned, and the revenues not generated are lost forever. In the first quarter of 2012, the demand for goods and services (actual gross domestic product—GDP—in the chart below) was about $893 billion (5.5 percent) less than what the economy was capable of supplying (potential GDP). The Congressional Budget Office estimates that the cumulative shortfall from the start of the recession in 2007 will be $5.7 trillion by the time the economy returns to full employment.
Under these circumstances, deficit-financed government spending or well-targeted tax cuts can increase economic activity and reduce the substantial waste associated with underutilized labor and other productive resources. The additional debt would likely still weigh on future growth, but the benefits from increasing current economic activity would be substantial. Policymakers can eliminate the future costs if they pair short-term stimulus with policies that reduce the deficit in the future when the economy is stronger.
Fears that further temporary deficit-financed fiscal stimulus would precipitate a debt crisis seem misguided at a time when investors around the world want the safety of U.S. Treasury securities. Comparisons between the U.S. situation and that of Greece or other southern European economies are off base.
Fears that further "quantitative easing" by the Federal Reserve to lower long-term interest rates will ignite inflation seem similarly off base. The Fed has a dual mandate—to promote high employment and stable prices. As illustrated in the chart below showing the unemployment rate and 12-month inflation rate, inflation over the most recent 12 months has fallen below the Fed's target for inflation, while the unemployment rate remains far above Congressional Budget Office's estimate of what it would be if the economy were operating at its potential.
In his public statements, Fed Chairman Ben Bernanke has expressed concern about the effect of a weak labor market, especially on the long-term unemployed, and he has asserted that the Fed has the tools it needs to provide further stimulus. But the actions of the Fed's monetary policy setting committee that he heads have not yet matched that concern with a more aggressive monetary policy.
Bernanke undoubtedly would like some help from fiscal policy. But that's a vain hope in today's fractured political climate, so the best hope for the unemployed and for a stronger economic recovery seems to lie with the Fed at this point.