The Economy in the 2012 Election

Andrew Samwick Dartmouth Club of the Upper Valley February 4, 2012

Our Objective Today

Since the U.S. economy is going to be the major issue in the race, we were hoping that you might be willing to discuss the economic situation, the jobs issue, the federal budget, etc.
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A Macroeconomic Refresher
Average Share of GDP 1995 2011 69.2 15.6 18.8 11.1 -14.7 100.0 (c) Andrew A. Samwick Standard Deviation of Quarterly Percent Change 1995 2011 2.3 14.7 3.1 9.7 9.5 2.8 3

GDP Component Consumption Investment Government Exports (Minus) Imports Total 2/4/2012

Changing GDP Shares

GDP Component Investment Government Consumption Net Exports 2007 Q4 15.9 19.2 69.8 -4.9 2008 Q4 13.6 20.6 70.0 -4.2 2009 Q4 11.3 20.9 70.9 -3.1 2010 Q4 12.3 20.5 70.6 -3.4 2011 Q4 13.1 19.7 71.0 -3.8

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The bursting of the tech bubble: -2% of GDP over 3 years.

The bursting of the housing bubble: -4% of GDP over 5 years.

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What Does All of This Tell Us?

Consumption is the largest component of GDP, but it is also the least volatile. Investment is the most volatile component of GDP. Investment drives the business cycle. From this perspective, we won t be out of the downturn until investment rates fully revert.

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Implications for the Labor Market

We can also see the business cycle play out in the labor market. There are two important news releases regarding the labor market:
The weekly Initial Unemployment Insurance Claims report The monthly Employment Situation Summary

Here s how to interpret both of them during the remainder of this election cycle.
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Meanwhile, in the Labor Market

Sustained Economic Expansions Require Weekly Initial UI Claims < 400,000

It is possible to approach 400,000 weekly initial claims without crossing it.

And look where we are now.

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So follow the news every Thursday morning at 8:30 a.m. to see if initial UI claims are staying below 400,000 (or 375,000, according to the AP).

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So What Is the Economic Situation?

I assert that there are three macroeconomic regimes, based on the monthly Employment Situation Summary and the market response.
When the net job growth number is negative or barely positive. When the net job growth number is positive and the stock market increases in response. When the net job growth number is positive and the stock market falls in response.
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Reading the Economic News

Weakly Positive or Negative Job Growth Economic growth is not supporting job growth. This could be due to negative GDP growth (a recession) or high productivity growth relative to GDP growth (a jobless recovery).
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Positive Job Growth, Positive Stock Market Response The economy is growing quickly enough to add jobs, but not reliably enough to cause the Fed to worry about curbing inflation or deflating bubbles.
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Positive Job Growth, Negative Stock Market Response The economy is growing so quickly that investors expect the Fed to raise interest rates, to lower inflation expectations or investor sentiment.
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Which Regime Are We In?

So follow the news on the first Friday of every month at 8:30 a.m. for any signs of a regime switch from yellow to green (and hopefully not back to red).
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On Politics, Will Any of This Matter?

NV

Unemployment Rate in December 2011 4 6 8 10 12

CA RI MS SC ID KY TN AL AR AK LA WY OK UT KS WV TX MT VA MN IA NH NE SD ND VT AZ GA NC FL IN MO OH CO PA WI ME NM MI NJ OR WA CT NY DE MA MD HI IL

30
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40

50 Obama Share in 2008

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60

70
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Zooming In on the Close Contests

10
NC GA FL

Vice President Rubio?

Unemployment Rate in December 2011 6 7 8 9

IN

Vice President Portman?

MO OH CO PA

MT

VA MN IA NH

5 46
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48

50 Obama Share in 2008

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52

54
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On Policy, What Have We Learned?

This recession, like the last two, has had a jobless recovery despite aggressive monetary policy.
Tight monetary policy didn t cause these recessions. Easy money won t necessarily end them.

These recessions are the result of a sectoral mismatch in the economy (the wrong kind of investment, too much consumption) The path out of these recessions is aggressive fiscal policy, not (just) easy monetary policy.
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The (Old) Principles of Fiscal Stimulus

To respond to an incipient downturn, fiscal policy has to have its impact in a timely manner. It has to be targeted to assure that increased government borrowing translates directly into increased spending and demand. And, critically, it has to be temporary so that its effects are not offset by higher long-term interest rates.
As stated by Summers (12/19/07), quoting Sperling (12/17/07). See also Elmendorf & Furman (1/10/2008). 2/4/2012 (c) Andrew A. Samwick 16

How Big Should This Stimulus Be?

Quoting Summers (late 2007):
It is reasonable to suggest that stimulus approaching $50-$75 billion -- roughly in the range of 1/2 of 1% of GDP -- is likely to be appropriate. The largest part of this stimulus should come in the form of tax cuts distributed equally among all taxpayers and recipients of tax refunds.

During the throes of the recession (early 2009):

Calls for additional stimulus of $1 trillion and more, with ARRA passed at $787 billion.
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Did the Stimuli Work?

Sahm, Shapiro, and Slemrod (2009) on the 2008 tax rebates:
Only about one-fifth of respondents in the Reuters/University of Michigan survey report that the 2008 tax rebates led them to mostly increase spending, while over half said it would lead them to mostly pay off debt. Of those in the mostly-spend category, the response was swift, with over 80 percent reporting increasing their spending within three months of receiving their rebate. Older households, households with higher wealth and higher income, and those expecting future income growth were generally more likely to spend the rebates.
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Did the Stimuli Work?

Feyrer and Sacerdote (2011) on ARRA, using variation in receipts by states and counties:
Their analyses suggest that one additional job was created by each $170,000 - $400,000 in stimulus spending.
Grants to states for education do not appear to have created any additional jobs. Support programs for low-income households and infrastructure spending are found to be highly expansionary.

Estimates excluding education spending suggest fiscal policy multipliers of about 2.0 with per job cost of under $100,000.
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I Disagreed With This Approach Early

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These Principles Are Not Aggressive Enough

The marketing is great. How could anyone want something untimely or untargeted? The problem is the temporary.
Temporary measures don t increase consumption unless a person is borrowing constrained (and even then, only temporarily). Temporary measures do not boost expectations of future activity and thus do not improve asset values or motivate longer term investments.
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Searching for a Better Way

Timely, targeted, and temporary elevates speed (and presumed multipliers) over value. It also emboldens opportunistic behavior in our budgeting process. Are there things of value that:
We currently need to invest in, The government has a critical role in providing, Provide benefits well into the future, and Can be prioritized and scheduled well in advance?
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Consider Infrastructure Investment

From the American Society of Civil Engineers 2009 report card:
An estimated $2.2 trillion is required over a fiveyear period to restore the nation s physical infrastructure to good condition. Only half of this is projected to be spent under current practices (including ARRA authorizations). Using the ASCE calculations, ARRA addressed only about 10% of the total estimated shortfall.
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A Capital Budget: As Stimulus

If we had a capital budget, some projects would be slated for completion each year. When economic growth falters, the government would be in a position to move some of the projects from later years into the present year. Having a plan in place allows these shifts to be timely, possibly targeted, and appropriately temporary.
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A Capital Budget: Advantages

It forces the government to establish priorities. It reduces overall expenditures (i.e., generates wealth) by doing more of the work in times of economic slack, when costs are lower. It also abides by pay-go rules, since projects moved up to 2009 need not be done in 2010. I believe that effective capital projects boost expectations in a way that tax rebates do not.
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Where Is Current Policy?

President Obama s infrastructure initiatives are in the low hundreds of billions.
ARRA had at most $100 - $150 bln (out of $787bln) He has repeatedly called for $50 billion for a National Infrastructure Bank. His rhetoric picked up around the midterm elections: This is Work That Needs to Be Done. There Are Workers Who Are Ready to Do It. [Speech on 10/11/2010, Treasury/CEA white paper released the same day]

These policies are an order of magnitude too small not nearly aggressive enough.
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Our Current Political Dynamic

ARRA + HASP = Tea Party Movement Begins within a month of President Obama s inauguration. The Tea Party was an extremely successful political movement. Consider how nothing like ARRA or HASP has been passed since the 2010 elections, despite ongoing need as defined by the President. Every policy President Obama has gotten passed since then has been with tax cuts (reflecting Republican priorities regarding tax cuts versus deficit reduction or capital investments).
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The Deficit Will Be An Issue in 2012

Current deficits are high by historical standards, due to lingering weakness in the economy and policy interventions. But projected deficits in the next decade will be high only if Congress and the President continue the policy interventions. Beyond that, our fiscal problems are solely due to population aging and excess health care cost growth.
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Historical Deficits as a Share of GDP

30 25 20 15 10 5 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Revenues
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Outlays
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Projected Deficits as a Percent of GDP: Baseline vs Alternative Policy

8 7 6 5 4
7

Additional Debt Service Prevent Spending Cuts Extend Tax Policies Baseline
3.7 2.1 1.5 1.6 1.4

3 2 1 0
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1.1

0.9

1.2

1.2

1.2

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Sources of Growth in Federal Spending on Major Mandatory Health Care Programs and Social Security

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In Conclusion
Our economy may be on the verge of a sustained recovery. Our fiscal policy problems are fixable, if we can put together a coalition in Washington to fix them. A parting question: Under which President are we more likely to see that coalition form, assuming no changes in the majorities in the House or Senate Obama or Romney?
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