Robert Reich’s latest post, “The Way to Prevent the Looming Recession.” argues that monetary policy won’t prevent the coming recession and therefore policy makers need to consider tax cuts:
With the economy heading for recession, all eyes are on Ben Bernanke and the Fed, and the question everyone is asking is how much the Fed will cut short-term interest rates to stimulate the economy. But a Fed rate cut won’t stimulate the economy. That’s because lending institutions, fearing their portfolios are far riskier than they assumed several months ago, won’t lend lots more just because the Fed lowers interest rates.
Average consumers are already so deep in debt — record levels of mortgage debt, bank debt, and credit-card debt — they can’t borrow much more, anyway. With average home prices dropping faster than they’ve dropped since the Great Depression, many can’t even refinance. And given last Friday’s report showing the first employment drop in four years, people are not in the mood to keep spending.
So if a Fed rate cut can’t prevent a recession, what can? Putting more money into American pockets by cutting their taxes. Yes, I know: Tax cuts have gone out of style ever since Democrats became born-again deficit hawks, and George Bush squandered the $5 trillion surplus he inherited in 2000 mainly by cutting taxes on the rich.
But with a recession looming, Democrats need to stop being the party of Herbert Hoover economics. And the Republican need to understand tax cuts for the rich won’t help because the rich don’t increase their spending when their taxes are cut. They already spend as much as they want to spend. That’s what it means to be rich.
It’s middle and lower-income Americans who spend more when their taxes are cut. And because the biggest tax they face is the payroll tax, the payroll tax needs to be cut in order to keep them spending and avoid a recession.
I say exempt the first $15,000 of earnings from payroll taxes for a year, starting as soon as possible. Sure, this may cause the budget deficit to widen a bit. But if the economy goes into the tank, the deficit will be far bigger.
Now just because Reich is simplistic and alarmist doesn’t mean that what he says is completely without merit (I attribute the broad brush style to his desire to reach a mass audience)
First, a recession seems highly likely, which means actions taken now probably won’t forestall one. And we may well see a bona fide recession (meaning two quarters of negative growth) but knowing how stats get tinkered with, don’t be surprised if we have low positive growth quarters later revised into negative territory.
Second, a recession isn’t the end of the world (we seem to have developed the same aversion to recessions that we have to wars that involve the loss of American lives. Numbers that were once routine are now unacceptable). But it’s possible that we could go into a deep recession that merits concerted action. In other words, it’s still worth having remedies in mind, but delay pulling the trigger until the trajectory is clear.
Third, Reich is likely correct that monetary policy will be ineffective. If, as Harvard’s Mohamed El-Erian pointed out, 17 interest rate increases didn’t slow the economy, why should cuts be any more successful? A big focus of discussion at the Fed’s recent conference at Jackson Hole was that we are having a crisis that is outside the banking system, but the Fed’s tools are all designed to address problems within the banking sector.
Fourth, if things get really bad, policy makers will need to look at fiscal remedies (even Nouriel Roubini has been advancing that view). Tax cuts, including the type Reich suggests, are an option.
Finally, however, I am disappointed that most commentators focus on monetary and/or fiscal fixes, and comparatively few are thinking seriously about the need to devise new financial regulations. That’s an integral part of any solution, one that takes considerable thought, and yet is getting the least attention.