How can recession be fought

This figure includes state and local government spending. Source: EPI analysis of data from Tables 1. In turn, this pace of public spending growth would have seen the U. At the state and local level, slow growth of public spending is even more pronounced than at the federal level, and state and local policymakers certainly deserve much of the blame for the slow recovery.

Just one example of austere spending policies at the subfederal level is the decision by 19 states to refuse free fiscal stimulus from the Medicaid expansion under the Affordable Care Act. The reason for this is simple: State and local policymakers face spending constraints that do not apply to federal policymakers.

Most specifically, these state and local policymakers by and large have to balance the operating portions of their budgets by law. States do not print their own currency.

This means that they really do have to be more cautious about running up debt that sometimes erratic financial markets can decide rightly or wrongly is unsustainable. In contrast, the federal government is free to run deficits. And because it can print its own currency, it does not have to ratchet interest rates ever higher if private investors are unwilling to absorb new public debt for a spell of time.

Even during normal times, transfers from the federal government to states account for more than 20 percent of total state and local resources for spending. There is no reason, other than politics, that federal aid to states could not have been more forthcoming in the face of such historically high need. Even the timing of austerity over the current recovery is fairly easy to pinpoint in the actions of Republicans in Congress.

The Obama administration championed and signed the American Recovery and Reinvestment Act ARRA during the recession in early , and the law led to a jump in government spending that persisted throughout the early stages of the recovery. Through the end of when the ARRA had mostly petered out , total government spending per capita was not that different from spending during previous recoveries and actually rose more rapidly than in previous cycles during the recession phase.

But in Republicans in the House of Representatives demanded spending cuts as a precondition for raising the debt ceiling, a vote that had historically been pro forma the ceiling has been raised 78 times since The resulting Budget Control Act of significantly reduced the growth of discretionary spending between and Both in word and deed, Republican lawmakers embraced and enforced fiscal austerity, and the result was the most moribund recovery on record until Of course, spending is just one prong of fiscal policy; taxes constitute the other.

In theory, fiscal policy may not have been as austere as Figure B would indicate if taxes had been cut much more steeply over the recovery from the Great Recession. While tax changes were indeed less contractionary than spending in those years, they were nowhere near expansionary enough to overturn the overall finding that recovery from the Great Recession was severely hampered by overly restrictive fiscal policy.

Figure C compares the business cycles of the s, s, 31 s, early s, and late s. The fiscal impulse stemming from these combined fiscal actions are measured either from peak to peak over the entire business cycle or, more relevantly, from the trough of the recession through the first three years of recovery.

The peak-to-peak measure includes the actions undertaken during the actual recession like the Recovery Act , while the measure from the trough plus three years shows the fiscal impulse aiding recovery from the recession. This fiscal impulse in the first three years of recovery was historically weak following the Great Recession—providing less than a tenth the spur to spending provided after the s and early s recessions, and less than a fifth the fiscal boost provided after the s and s recessions.

It is exactly this kind of premature swing into austerity that policymakers must avoid at all costs as the economy enters the next recession. Note: For each fiscal component taxes, transfers, and government consumption and investment , the quarterly growth rate is multiplied by its share relative to overall GDP to get a quarterly contribution to growth. For taxes, this calculation is then multiplied by negative one—highlighting that tax cuts boost spending while tax increases slow spending.

The figure shows these quarterly contributions expressed as annualized rates. Government consumption and investment spending is adjusted for inflation with the component-specific price deflator available in the NIPA data. For taxes and transfers, the price deflator for personal consumption expenditures PCE is used.

A growing conventional wisdom holds that the United States is poorly prepared to face the next recession because it lacks fiscal space to undertake stimulus, and lacks monetary space given short-term interest rates that are not very far above zero the federal funds rate is currently set to a range between 2. The broader argument—that we have done a terrible job preparing for the next recession—is fair.

The given reasons—a lack of fiscal and monetary space—are not. The evidence presented to justify claims of little fiscal space is usually just the federal debt as a proportion of GDP. This ratio in But the measure is an extraordinarily imprecise gauge of fiscal space, and is fundamentally backward-looking, picking up the legacy of past decisions regarding spending and taxes.

More sensible measures of fiscal space would look at future determinants—for example, projected deficits or projected tax burdens relative to other advanced economies. Using these forward-looking measures, by many respects the fiscal space available to the U. This willingness to hold U. Note: Federal debt service refers to interest paid on federal debts. Here it is shown as a percent of GDP. It is clearly true that short-term interest rates will not be able to be cut very far before hitting the zero lower bound in the next recession.

But monetary policy, as noted above, has always been weak tea when it comes to fighting recession and spurring growth. In short, there is little evidence that a lack of monetary space will be particularly constraining for future stimulus efforts either. The United States will head into the next recession with a number of structural drags on growth in aggregate demand.

The largest structural drag is continued high levels of income inequality. Another important obstacle is an inflation target that was set too low and has been insufficiently defended against undershooting for a decade. Besides these mechanical drags stemming from inequality and too-low inflation, the response to the next recovery is likely to be hampered by our failure to properly rein in the power of finance following the Great Recession.

Finally, and most importantly, the overwhelming empirical and intellectual case for aggressively using fiscal policy to end the next recession quickly and restore full employment has not filtered through sufficiently to policymakers.

Instead, ingrained habits of thinking have led far too many policymakers to see budget deficits as nearly always and everywhere bad. The rise in American inequality in recent decades is now well-recognized. It is also well-documented that, all else being equal, a redistribution of income from low- and middle-income households toward rich households is likely to sap aggregate demand growth. Bivens a finds that the rise in inequality since reduced aggregate demand by as much as 4 percent in , holding other influences constant.

For much of the period from to , other influences helped counteract this inequality-induced drag on demand. Key influences included a secular decline in interest rates as excess savings from rich households put downward pressure on rates and a number of asset market bubbles that sustained consumption growth for a time. But the underlying level of aggregate demand today is far lower than it would be had the post rise in inequality never happened, and this makes the job of avoiding and exiting recessions harder.

While the causes of this rise in inequality are beyond the scope of this paper, the roots are clearly political: Far too often in recent decades policies were enacted that explicitly redistributed bargaining power and leverage in the labor market away from low- and middle-wage workers and toward corporate managers and capital owners.

When nominal interest rates hit zero, real inflation-adjusted rates will equal zero minus the expected rate of inflation. In recent years, as the zero lower bound ZLB on nominal interest rates was reached, higher inflation that drove real interest rates significantly lower than zero would have been most welcome.

But instead the Fed in made official what had long been suspected: Their preferred inflation target was just 2 percent. This 2 percent expected inflation made the ZLB bind tightly in the recession, as it meant real rates could only be pushed to negative 2 percent, when even lower real rates were needed. A higher inflation target would provide more room for nominal interest rate cuts to boost the economy in the next recession.

Given the growing frequency of advanced economies around the world hitting the ZLB in recent decades, and given that the influences leading to this are generally well-known and unlikely to be reversed soon, the case for the Fed adopting a higher inflation target is strong.

The case for this is summarized in Bivens b. Even worse than having an inflation target that is too low is consistently undershooting this too-low target. Yet this is precisely what the Fed did, with the cumulative annualized gap between the target and actual inflation reaching 5 percentage points between and the end of Falling inflation expectations could in turn promote higher real interest rates.

Because real interest rates are nominal rates minus the rate of expected inflation, these rates rise as inflation falls. Going into the next recession, it seems our target inflation rate is not only too low, but it has also been poorly defended against undershooting.

This could certainly hurt the next recovery. Federal Reserve aid explicitly tied to providing support for the financial sector began in August and continued for years; it included the creation of historically unprecedented programs to provide liquidity to financial institutions.

This finance-directed aid certainly worked to relieve the fallout of the crisis on these institutions and stem financial market stress. By early measures of this financial market stress like spreads between Treasury bond interest rates and other rates had largely returned to normal, and stock market indices began growing again. This early return to near-normality in the finance sector probably sapped the urgency among policymakers to ensure a full recovery for all, not just banks.

Yet policymakers have largely ignored any measures that might restrain the political power of finance writ large. The recent spate of rollbacks to financial regulations shows the costs from this failure to policymaking priorities and integrity. Next time around, we must ensure that the distress of typical families, not the balance sheets of financial firms or asset prices, is the primary concern of policymakers. We noted earlier that recovery from the Great Recession began faltering in with the passage of the Budget Control Act.

This stumble occurred, at least in part, because of a premature retreat from touting the need for expansionary fiscal policy and toward genuflecting before the conventional wisdom that we need deficit reduction.

A prime example was in the January State of the Union address— when the unemployment rate was 9. But families across the country are tightening their belts and making tough decisions. The federal government should do the same.

White House Since then, we have seen overwhelming evidence of the benefits of fiscal expansion to end recessions—and no indication that higher budget deficits are harming the U. Yet politicians on both sides of the aisle just keep reflexively paying lip service to the perceived need for smaller budget deficits.

And the need for fiscal stimulus in the last decade lasted far, far longer than the official recession did. In short, the large gulf between conventional wisdom and state-of-the-art economics—which now argues strongly for an aggressive fiscal role in restoring full employment even after a recession has officially ended—is worrisome.

The unemployment rate jumped from 4. It did not rise for any other reason, and the pace of the recovery post was entirely dictated by the pace of spending growth. Yet implausible alternative explanations were floated and taken seriously by policymakers early on in the recovery.

Others said regulatory overreach was prolonging the labor market slump. The evidence for these alternative explanations was completely lacking, yet even President Obama in was reported to have demanded that his economic advisers provide solutions to ongoing joblessness besides efforts to boost spending. This failure to understand the real root cause of higher unemployment has not been rectified.

As the next recession hits, it is dead certain that many policymakers and economic observers will begin offering reasons for the rise in joblessness besides the real one. Accordingly, a key task for analysts and organizers to accomplish before the next recession is to make it harder for policymakers to get distracted by fake explanations.

The menu of policy options to fight the next recession needs to be ruthlessly culled down to items that will actually work. Given that all of them would work to solve the central cause of recessions and slow recoveries, and given the overwhelming importance of just getting fiscal policy oriented in the right direction for a sustained period, the answer to this should be driven in large part by politics.

In short, we should construct an expansionary fiscal program that is designed to be effective economically but also durable politically—and that can draw excitement and support from key organized constituencies. This kind of overtly political analysis is not what normally motivates policy wonks in the macroeconomic sphere. Maybe Republican opposition would always have been impossible to overcome and the sharpest political thinking in the world would not have made a difference. But we all owe it to the American people to think harder next time about these issues.

Fiscal contractions are policy changes that either reduce public spending or increase taxes, each of which reduces the pace of spending growth.

After the coronavirus: America needs to reengage with the world, not retreat from it. Most notably, in October , major central banks across the world cut interest rates simultaneously. And with the threat of another Great Depression looming, the Group of 20 leading nations became a powerful, action-oriented body, convening heads of state and government in coordinating a global response to the crisis.

These actions were key to staving off the worst and repositioning the world economy toward growth. Unlike a decade ago, this time we are fighting a real contagion. Market unions that were once strong have been tested by fracture. And many countries have looked at shared challenges, such as climate change, through a prism of competition rather than coordination.

This is before needed stimulus has been spent. But like a decade ago, it would be a mistake for leaders to think they can respond to the crisis alone. While the coronavirus necessitates the distancing of those who are sick and the closure of borders in some instances, these measures cannot be prescriptions for our long-term economic well-being.

As the virus abates, countries will need to strengthen global commerce together and ensure those countries challenged by less resources in reserve have the means to recover. Leaders are hopefully looking back and approaching the recovery in a posture of coordination. This article was originally published on USA Today. The views expressed in this article are those of the author alone and not the World Economic Forum.

High rates of COVID infection are setting Africa back but young innovators across the continent are deploying a social entrepreneurship skillset to fight the pandemic from the grassroots. I accept. A little more than 10 years ago, as the world was entering the Great Recession, stakeholders had to look far back in the rearview mirror to the Great Depression for policy guidance.

While the actions of the s did offer important lessons for — most notably the need to expand the money supply — the economy of the s was fundamentally different than the global economy of the early part of this century.

Compared with the s, stakeholders in were operating in an interconnected world with a global financial system and were therefore largely in unchartered waters. If there is a silver lining in the economic portion of the crisis we are seeing unfold today, it is that the relatively compressed timeline between and today means there is great relevance in one of the most consequential approaches policymakers employed then.

In particular, the lesson of is that a globalized economy necessitates a global solution. Today, the economic outlook for the world is bleak, with the coronavirus crisis already causing one of the most severe shocks to global growth in a century. Projections are that the second quarter of will be the worst quarter in generations. Also read : How will you restart the economy? There is no perfect answer. Most notably, in October , major central banks across the world cut interest rates simultaneously.

And with the threat of another Great Depression looming, the Group of 20 leading nations became a powerful, action-oriented body, convening heads of state and government in coordinating a global response to the crisis. These actions were key to staving off the worst and repositioning the world economy toward growth. Unlike a decade ago, this time we are fighting a real contagion. Market unions that were once strong have been tested by fracture.