Andrew A. Samwick is a professor of Economics and director of the Nelson A. Rockefeller Center for Public Policy and the Social Sciences at Dartmouth College.
This month marks five years since the start of the Great Recession, which began in December 2007 as nonfarm payroll employment peaked. Although the National Bureau of Economic Research would not officially declare it for nearly a year, smart observers of the economy could see in real time that weakness in the housing and financial markets was spilling over into the economy as a whole. In his remarks at the Brookings Institution on Dec. 19, 2007, Lawrence Summers, who would go on to serve as chairman of the National Economic Council under President Obama, provided a very clear diagnosis of the looming challenges.
The fiscal policy response that emerged from that diagnosis, however, was ill-suited to the challenges. The mantra that guided both the small stimulus legislation signed by President George W. Bush in January 2008 and the much larger stimulus legislation signed by President Barack Obama a year later was that fiscal stimulus should be "timely, targeted, and temporary." The Brookings Institution went so far as to publish a primer on fiscal stimulus emphasizing this approach. One can only hope that with five years of hindsight and a continuing struggle to recover from the Great Recession, this approach has been discredited.
This approach—timely, targeted, and temporary—emphasizes a short-term effort primarily to sustain consumption and, secondarily, to accelerate private investment. It is fine when the objective is to iron out some wrinkles in the business cycle or to alleviate some of the economic dislocation when the Federal Reserve raises interest rates to curb inflation expectations.
When the economic slowdown is due instead to the collapse of an asset price bubble, like our recent experience in the housing market, a different approach is needed. Rather than timely and targeted to private consumption and investment, fiscal stimulus needs to be sustained and targeted to long-lived public investment projects. Most importantly, fiscal stimulus cannot be temporary. Temporary measures by the federal government do not boost expectations of future activity and thus do not improve asset values or motivate longer term investments by firms, households, or other investors. A better way to deal with downturns caused by weakness in a sector like the construction industry is to be ready with substantial capital outlays to employ those displaced workers to address long-term investment needs in the public sector. To the extent they were tried in the American Recovery and Reinvestment Act of 2009, capital projects came in on schedule and under budget.
Acknowledging the missteps in our early response to the Great Recession is important because, unfortunately, the legacy of "timely, targeted, and temporary" is still contaminating the discussions in Washington about how to avoid the so-called fiscal cliff. The fiscal cliff embodies two different problems. The first problem is that we do not have a tax system that raises enough revenue to cover our expenses. This was true even at the peak of the last business cycle, to say nothing of the trillion dollar annual deficits since. The second problem is that we must still use fiscal policy, in combination with sustained accommodation in monetary policy, to emerge finally from the Great Recession.
We would do well to separate the two problems. Rather than fall into the same pattern of discussing which temporary tax measures might be extended (yet again) with an eye toward sustaining personal consumption, we should simply let all tax changes expire as scheduled. This would solve the first problem—we would then have a tax system that would not substantially increase our debt-to-GDP ratio over a complete business cycle. We could then turn our attention to the second problem without the constraints of having to work primarily with the tools of extending the expiring tax changes.
The federal government could announce, for example, that it will commit $300 billion annually for the next four years to rectify the deficiencies in public infrastructure identified by the American Society of Civil Engineers in its last report card that have not already been addressed. Much like what would happen if we go over the fiscal cliff, economic activity would not change dramatically on January 1. But households, firms, and investors would know that the long-standing problems in public infrastructure would be on a timetable for improvement. Expectations would change immediately. Improved public infrastructure would also increase the productivity of existing and additional private investments as well, which might just be the last step that is needed to make sure that the Great Recession's sixth birthday is happier than its fifth.