Indeed, if you want a simple model for predicting the unemployment rate in the United States over the next few years, here it is: It will be what Greenspan wants it to be, plus or minus a random error reflecting the fact that he is not quite God
Though I can't find it; I've seen a policy bit from Larry Summers dating from the '80s or so that was extremely dismissive of the possibility of any fiscal stimulus. This sort of general impulse had knock on effects on all sorts of other policy debates. For instance, future Obama Administration official Jason Furman argued in favor of Wal-Mart in a Slate debate, in which one of his points was:
I believe that Ben Bernanke and the Federal Reserve decide the total number of jobs nationwide.
The general idea was that -- let's hand off the task of aggregate demand management to the Fed, and then otherwise pursue as many pro-growth strategies as possible. Who cares if Wal-Mart costs a few jobs somewhere? The Fed will create them elsewhere. Who cares if free trade results in the loss of a few jobs in Ohio? We'll make enough money from positive-sum trade interactions to make the deal worthwhile, and possibly redistribute back to those newly unemployed. With a strong economy, hopefully they can be retrained and find new jobs.
One of the things that we've seen in the last few years is that this belief has broken down entirely. No one seems to believe that the Fed bears the brunt of the work in generating jobs; or that fiscal stimulus is a typically unworkable solution to economic woes. Instead, we've come to see the economy overall as "Y = C + I + G + X" and think "If government spending goes down even a little bit, the economy will grow unacceptably slowly." More generally, the sorts of positive-sum economic interactions we loved in the past are less popular, because any negative side effects they generate are seen as imposing unacceptable burdens on struggling folks.
And so you have various people complaining about what this debt deal or what future cuts will have on jobs. This is just a type of debate we never really had before now; in the early 2000s for instance, you had the Republicans proposing a "Keynesian" strategy of lower taxes, while Democrats opposed that. But the aggregate demand management aspect of those cuts was less important than their inherent value as tax cuts.
Opinions on the composition of government spending or taxes differ. We should, in theory, be able to have perfectly reasonable discussions about how much we ought to spend or tax without worrying inordinately about how those discussions affect the labor market. If a central bank is properly targeting inflation or the price level, it will lean against government spending in either direction, meaning that no level of government spending has any effect on the economy in aggregate. That way, we can spend all of our time arguing whether or not any particular spending or tax bill makes sense on its own merits. People back in the '90s and '80s had the right idea.
We've sort of stopping doing that. A strong goal on the left seems to be ensuring that government spending remains as high as possible; because otherwise that will ensure doom to a poorly functioning recovery. On the right, the goal too is to keep taxes as low as possible, because households too are struggling. Perfectly reasonable policy debates have become infected with the idea that the balance of public spending and taxation is the primary determinant of broader economic outcomes. So you can't argue in favor of any sort of spending cuts without being some kind of economic arsonist.
I suppose one critique of this is that given such a large output gap and a Fed unwilling to adopt price-level targeting, an inordinate focus on the total amount of government spending makes sense. My response is that it must surely be easier to have the Fed do now what it did during the '90s, so Krugman can again write about how the unemployment rate is set by the Fed, so politicians can spend and tax as they please.
There's the other critique I guess that monetary policy can't perform the same function now due to the zero rate bound, or weak banks, or struggling households. All I can say is: there is an enormous literature on monetary policy, and exactly none of it focuses on the barriers to monetary policy, as least as far as I know. None of it says, "monetary policy works if X, Y, and Z happen." Monetary policy just works, at least in theory.
In practice, we saw monetary policy drive the recovery in 1933 when FDR took the US off of the gold standard, in an environment in which we also were at a zero rate bound; faced weak banks; and financially indebted households. The initial reaction of the economy to the first round of quantitative easing under exactly these conditions was positive; as was the reaction in the second round. The only real counterpoint seems to be the case of Japan. Yet as Scott Sumner has mentioned repeatedly; the Japanese Central Bank really seems to behave as if it does like a zero percent rate of inflation, and QE has helped them maintain that.
But fine, suppose you say I'm crazy for focusing on monetary policy so much. What about other broader labor market policies? Garett Jones links to a paper on the German labor force experience, which basically finds that their flexible labor markets did a great deal to limit the employment impact of the Great Recession. Why isn't there a greater focus on generating specific policies to target unemployment, rather than worrying every time the government spends a penny less?
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