Monetary and fiscal policies in the US, both in this recession and the recession of 2001, have been among the most accommodating in the industrial world. As I write, Congress is working on yet another “jobs” Bill. Indeed, John Taylor of Stanford University attributes the recent financial crisis to excessively stimulatory monetary policy towards the end of Alan Greenspan’s tenure as head of the US Federal Reserve.
Why is US policy so accommodating? A central reason is that the nature of US economic recoveries has changed. From 1960 until 1991, recoveries were typically rapid. From the trough of recessions, recovery to pre-recession output levels took less than two quarters on average, and employment recovered within eight months.
But the recoveries from the recessions of 1991 and 2001 were different. For example, in 2001, it took just one quarter for output to recover, but 38 months for jobs to come back. The current recovery appears to be similarly slow in creating jobs.
Some economists argue that, unlike past recoveries, when workers who were temporarily laid off were rehired, job losses starting in 1991 were more permanent. Unemployed workers had to find jobs in new industries, which took more time and training.
Others suggest that the Internet has made it easier for firms to hire quickly. So, rather than hire in panic at the first sign of a recovery for fear that they will be unable to do so later and lose sales, firms would rather make sure that the recovery is well established before adding workers.
Photo: Bill Pugliano/AFP
Regardless of the true explanation, the US is singularly unprepared for jobless recoveries. Typically, unemployment benefits last only six months. Moreover, because healthcare benefits are often tied to jobs, an unemployed worker also risks losing access to affordable healthcare.
Short-duration benefits may have been appropriate when recoveries were fast and jobs plentiful, because the fear of losing benefits before finding a job may have given workers an incentive to look harder. But with few jobs being created, a positive incentive has turned into a source of great anxiety. Even those who have jobs fear that they could lose them and be cast adrift.
Politicians ignore popular anxiety at their peril. President George H.W. Bush is widely believed to have lost his re-election bid, despite winning a popular war in Iraq, because he seemed out of touch with public hardship following the 1991 recession. That lesson has been fully internalized. Economic recovery is all about jobs, not output, and politicians are willing to push for economic stimulus, both fiscal (tax cuts or government spending) and monetary (lower short-term interest rates), until jobs start reappearing.
In theory, this is what democracy is all about—policy responding to the needs of the people. In practice, though, public pressure to do something quickly enables politicians to run roughshod over the usual checks and balances on government policymaking.
Long-term spending and tax policies are enacted under the shadow of an emergency, with the party that happens to be in power at the time of the downturn getting to push its pet agenda. Much of what is enacted as stimulus has little immediate effect on job creation, but does have an adverse long-term effect on government finances. For example, the 2009 stimulus package enacted by the Obama administration had many billions of dollars devoted to cancer research, though such research employs few people directly and is spent over a long-time horizon—far beyond that of even a prolonged recovery.
Equally deleterious to economic health is the recent vogue of cutting interest rates to near zero and holding them there for a sustained period. It is far from clear that near-zero short-term interest rates (compared with just low interest rates) have much additional effect in encouraging firms to create jobs when powerful economic forces make them reluctant to hire. But prolonged near-zero rates can foster the wrong kinds of activities.
For example, households and investment managers, reluctant to keep money in safe money-market funds, instead seek to invest in securities with longer maturities and higher credit risk, so long as they offer extra yield. Likewise, money fleeing low US interest rates (and, more generally, industrial countries) has pushed up emerging market equity and real estate prices, setting them up for a fall (as we witnessed recently with the flight to safety following Europe’s financial turmoil).
Moreover, even if corporations in the US are not hiring, corporations elsewhere are. Brazil’s unemployment rate, for example, is at lows not seen for decades. If the Fed were to accept the responsibilities of its de facto role as the world’s central banker, it would have to admit that its policy rates are not conducive to stable world growth.
Policy would still be accommodative if the Fed maintained low interest rates rather than the zero level that was appropriate for a panic. And this would give savers less of an incentive to search for yield, thus avoiding financial instability.
Politicians will not sit quietly, however, if the Fed attempts to raise rates. Their thinking—and the Fed’s—follows the misguided calculus that if low rates are good for jobs, ultra-low rates must be even better.
Emerging studies on the risk-taking and asset-price inflation engendered by ultra-low policy rates will eventually convince Fed policymakers to change their stance. But if politicians are to become less anxious about jobs, perhaps we need to start discussing whether jobless recoveries are here to stay, and whether the US safety net, devised for a different era, needs to be modified.
Raghuram Rajan is a former chief economist of the International Monetary Fund, and is professor of finance at the University of Chicago. He is also the author of Fault Lines: How Hidden Fractures Still Threaten the World Economy
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