[A-List] The Dispute Over What Constitutes Sound Fiscal Policy By Henry C.K. Liu
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Mon Aug 30 14:41:00 MDT 2010
The Dispute Over What Constitutes Sound Fiscal Policy
Henry C.K. Liu
This article was rejected by the editor of New Deal 2.0 for being too
dense for the general public.
It was pulbished in AToL on August 12, 2010
There is an undisputed general law in public finance that sound fiscal
policies must precede a sound currency. What is in dispute is what
constitutes a sound fiscal policy. Neoliberals deem recurring fiscal
deficits as signs of unsound fiscal policy. Yet over the multi-year
duration of most recession phases of business cycles in market
economies, multi-year deficit financing to stimulate economic
activities in a recession can be a very sound fiscal policy.
Under such circumstances, a balanced annual budget would be quite the
opposite of a sound fiscal policy. Still, some recessions may take
more than a decade to recover even with persistent fiscal deficits if
the funds are spent on wrong targets, as in the case of Japan after
the Plaza Accord of 1985.
The Situation in Japan
In Japan after Plaza Accord, the fiscal deficit did not help the
Japanese economy because it had been spent on the wrong targets.
Realistically, reducing the debt/GDP ratio is difficult with only
fiscal reform: the economy must also be on a growth path.
As the fiscal deficit widens, the Bank of Japan bought up larger
amounts of government bonds to avoid disruption in the government bond
market. In this sense, Japan today resembles post-World War II United
States where the Federal Reserve implemented a bond price support
policy to keep interest rates low.
Moreover, just as the exchange rate of the dollar was not damaged by
Federal Reserve policy of bond support to keep interest rate low, the
bond-buying trend in Japan has not lowered market confidence in the
yen. Similar to the US in that period, Japan is a creditor that enjoys
a persistent current account surplus. Thus Japan has the strength to
ward off market challenges to confidence in its currency despite the
mounting government debt financed by the central bank.
US policy after World War II was to buy government bonds by
quantitative easing to check rampant rise in public debt, and to
leverage economic growth for a soft-landing of the debt/GDP ratio.
Japan today is similar in that the Bank of Japan is buying a limited
amount of government bonds, but differs in that it shows no signs of
halting growing debt and is falling into deflation and economic
Quantitative easing (QE) describes a central bank monetary policy to
increase the supply of money in an economy when the bank interest
rate, discount rate and/or interbank interest rate are either at, or
close to, zero. A central bank does this by first crediting its own
account with money it has created ex nihilo (out of nothing). It then
purchases financial assets, including government bonds and corporate
bonds, from banks and other financial institutions in a process
referred to as open market operations. The purchases, by way of
account deposits, give banks the excess reserves required for them to
create new money by the process of deposit multiplication from
increased lending in the fractional reserve banking system. The
increase in the money supply thus stimulates the economy. Risks
include overeasing, spurring hyperinflation, or the risk of not being
effective enough, if banks opt simply to pocket the additional cash in
order to increase their capital reserves in a climate of increasing
defaults in their present loan portfolio. The latter seems to be what
has happened in 2009 in US banks.
Post-Napoleonic War England shows that fiscal deficits can be cut even
under deflation. In England’s case, however, improved productivity
after the industrial revolution and the subsequent population increase
generated high growth that more than offset deflation and helped lower
the debt ratio. Japan, however, suffers not only low growth but also
population decline; reducing the debt/GDP ratio under deflation seems
unrealistic. The US economy will face population growth problems if
current anti-immigration sentiments continue. Coupled with slow
growth, the US economy will face many of the same problems faced by
Japan in her lost decade.
Like the US, Japanese citizens share a sense of urgency regarding
Japan’s fiscal health. In a public opinion poll, 60% of respondents
already think that “raising consumption tax is unavoidable to maintain
the social security system” (“Yomiuri Shimbun”, November 2009 survey).
Behind such opinion is the heightened sense of crisis concerning
Japan’s deteriorating fiscal health following the Lehman bankruptcy
shock; stronger understanding that new financial resources are
necessary to improve child-rearing support and impoverished
healthcare; and the reality that even “budget screening” will only
produce marginal revenue. Recent media coverage juxtaposing Greece’s
crisis with Japan’s fiscal situation may also be contributing to
public awareness. Yet the US, unlike Japan, does not enjoy a trade
surplus to tap the consumption of other economies to cushion a
reduction of its own fiscal deficits spending.
Japan’s 2009 government debt ratio is on par with post-Napoleonic War
England (accumulative long-term debt reached 171%, of GDP). The
government bond market survives because almost all of the bonds are
denominated in yen and held domestically (about 95%), and there is
significant political room to raise taxes in the future. Japan’s
current 25.1% tax burden ratio (fiscal 2008) is low compared to
European countries (England 37.5%; France 37.6%; Sweden 51.5%), and
the possibility of a consumption tax hike is particularly high. If
citizens recognize that their tax burden is low and accept a higher
consumption tax there is no reason why the government bond market
should collapse from worries over bond redemption. As society ages and
the savings rate falls, however, Japan does face a gradual decline in
its capacity to absorb government bonds.
Of course, to reduce the debt ratio Japan must not only raise taxes
but also shake free from deflation and embark on an economic growth
track (high nominal growth that yields a degree of inflation). Japan
is fortunate to be in proximity of rapidly growing emerging markets
such as China, affording it great potential to maintain growth by
maximizing such demand. Whether Japan can really leverage this demand
is unclear, but the potential leaves the door open to fiscal reform.
While Japan’s fiscal situation is therefore severe, there are paths
towards improvement such as tax raises and growth. The issue is
whether there is the political will to stanch further fiscal
deterioration and make tax hikes and growth a reality. Absent a show
of government will in this direction, the market will focus only on
the negatives such as a falling capacity to absorb government bonds
and difficulties in spurring growth and raising taxes. Japan will be
expected to become a deficit country even if it enjoys a current
account surplus at that point. Of the forces that pressure the
government towards fiscal prudence, market pressure such as rising
long-term interest rates should come into play.
Moderate pressure from the market notwithstanding, Japan will likely
end up raising taxes and address the problems without inviting
disturbance in the market. The Bank of Japan will then need to provide
financial support to foster an environment favorable to realizing high
The Situation In the EU
In March 2005, the EU’s Economic and Financial Affairs Council
(ECOFIN), under the pressure of France and Germany, relaxed the rules
to respond to criticisms of insufficient flexibility and to make the
pact more enforceable. Permissiveness infested the theoretical
regulatory framework at the boom phase of the business cycle.
At the urging of Germany and France, the ECOFIN agreed on a reform of
the Stability and Growth Pact (SGP). The euro convergence criteria as
spelled out in the SGP are:
1. Inflation rates:
No more than 1.5 percentage points higher than the average of the
three best performing (lowest inflation) member states of the EU.
2. Government finance:
Annual government fiscal deficit:
The ratio of the annual government fiscal deficit to GDP must not
exceed 3% at the end of the preceding fiscal year. If not, it is at
least required to reach a level close to 3%. Only exceptional and
temporary excesses would be granted for exceptional cases.
The ratio of gross government debt to GDP must not exceed 60% at the
end of the preceding fiscal year. Even if the target cannot be
achieved due to the specific conditions, the ratio must have
sufficiently diminished and must be approaching the reference value at
a satisfactory pace.
3. Exchange rate:
Applicant countries should have joined the exchange-rate mechanism
(ERM II) under the European Monetary System (EMS) for two consecutive
years and should not have devaluated its currency during the period.
4. Long-term interest rates:
The nominal long-term interest rate must not be more than 2
percentage points higher than in the three lowest inflation member
The ceilings of 3% of GDP for budget deficit and 60% of GDP for public
debt were maintained, but the decision to declare a country in
excessive deficit can now rely on certain parameters: the behavior of
the cyclically adjusted budget, the level of debt, the duration of the
slow growth period and the possibility that the deficit is related to
productivity-enhancing procedures. The pact is part of a set of
Council Regulations, decided upon the European Council Summit on March
22-23, 2005. Having adopted unneeded permissiveness at the boom cycle,
Germany is now leading the charge to reduce fiscal deficits in
eurozone by promoting austerity programs in every eurozone member
state in the midst of a severe recession.
The Curse of IMF Conditionalities
The problem with the IMF “conditionalities” cure in a sovereign debt
crisis is its insistence on a balanced fiscal budget at the wrong time
– during a monetary-induced recession, thus adding to the economic
pain unnecessarily and assigning disproportional burden on the most
defenseless segment of the population – the working poor, and
condemning the impaired economy to an unnecessarily long path toward
See full article
The Issue of Fiscal Deficit
Some are concerned that long-term Federal debt may balloon up to 180% of GDP.
While this development should be arrested by fiscal prudence, that is
perhaps only half of the solution. The other half is to direct the
fiscal deficit toward GDP growth. Sometimes a large fiscal deficit can
help actually reduce its share of the GDP if the fiscal deficit
generates a bigger GDP.
The Federal fiscal deficit in 1919 was 16.8% of a GDP of $78.3
billion. The war time Federal deficit in 1945 was 24.1% of a GDP of
$223 billion. Despite a high fiscal deficit, US GDP kept rising after
the WWII to $275.2 billion in 1948 with a fiscal surplus equaling 4.3%
of GDP. The 2010 Federal deficit is project to be 10.6% of a GDP of
Between 1920 and 1929, the Federal budget had a small surplus, while
the GDP grew to $103.6 billion in 1929. After the 1929 crash, the 1930
GDP fell $12.4 billion, about 12%, to $91.2 billion, while the Federal
budget under Hoover still had a surplus of 1% of GDP.
Not until Franklin D Roosevelt came into office in 1933 when the GDP
had fallen by almost half to $56.4 billion that the Federal deficit
jump to 3.27% of GDP in 1934. All through the New Deal years, the
Federal fiscal deficit stayed below 5% with the average annual deficit
at around 3% of GDP and did not rise until after the US entered WWII
and peaked at 28.1% in 1943, 22.4% in 1944 and 24.1% in 1945 but
falling to 9.1% in 1946 when the GDP was $222.2 billion.
The total Federal fiscal deficit for the four years of WWII was about
100% of the average annual GDP of the same period. At the same time,
the US grew to be the strongest economy of the world because the
fiscal deficit was used to finance war production, not to bail out
distressed financial institutions and inefficient industrial firms.
US fiscal deficit for FY2009 was more than $1.75 trillion -- about
12.3% of GDP, the biggest since 1945. According the White House Budget
Office, the cumulative fiscal deficit between FY2009 and FY2019 is
projected to be almost $7 trillion. Total gross Federal debt in 2008
was $10 trillion, projected to rise to over $23 trillion in 2019. Debt
held by the public is projected to rise from $5.8 trillion in 2008 to
$15.4 trillion in 2019. Interest expense in 2008 was $383 billion.
Projection is expected to rise as both debt principal and interest
rate are expected to rise.
The Issue of Inflation
Inflation is a different story. Moderate inflation is necessary for
optimum economic growth, provided the burden of inflation is equally
shared by all segments of the population, particularly not merely on
wage earners. By the end of World War I, in 1919, US prices were
rising at the rate of 15% annually, but the economy roared ahead as
wages were rising in tandem with or slightly ahead of prices through
Income policies involving wage-price control were employed throughout
history from ancient Egypt, Babylon under Hammurabi, ancient Greece,
during the American and French revolutions, the Civil War, World War I
and II. A case can be made that that wage-price control has a mixed
record as a way to restrain inflation, but it is irrefutable that
income policies are effective in balancing supply and demand.
Yet in response to inflation, the Federal Reserve Board raised the
discount rate in quick succession in 1919, from 4% to 7%, and kept it
there for 18 months to try to rein in inflation by making money more
expensive when banks borrowed from the Fed. The result was that in
1921, 506 banks failed.
The current financial crisis started in late-2007 and stabilized
around mid-2009 after direct massive Fed intervention. It was by many
measures an unprecedented phase in the history of the US banking
system. In addition to the systemic stress and the stress faced by the
largest investment and commercial banks, 168 depository institutions
failed from 2007 through 2009. This was not the largest number of
bank failure in one crisis. At the height of the savings and loan
(S&L) crisis from 1987 to 1993, 1,858 banks and thrifts failed.
However, the dollar value of failed banks assets in the financial
crisis in 2007-2009 was $540 billion, roughly 1.5 times of the bank
assets that failed in the S&L crisis in 1987-1993.
A research paper funded by the Federal Deposit Insurance Corporation
(FDIC) on Bank Failures and the Cost of Systemic Risk: Evidence from
1900-1930, by Paul Kupiec and Carlos Ramireza (July 2008) found that
bank failures reduce subsequent economic growth. Over this period, a
0.12 percent (1 standard deviation) increase in the liabilities of the
failed depository institutions results in a reduction of 17 percentage
points in the growth rate of industrial production and a 4 percentage
point decline in real Gross National Product (GNP) growth. The
reductions occur within three quarters of the initial bank failure
shock and can be interpreted as a measure of the costs of systemic
risk in the banking sector. The FDIC had been created by the New Deal
only after 1934 to protect depositors.
In the current crisis that began in mid-2007, with the discount rate
falling steadily to 0.5% on December 16, 2008 from a high of 6.25% set
on June 2006, still 25 banks failed in 2008 and were taken over by the
FDIC while 140 banks failed in 2009 and 33 banks failed in just the
first two months of 2010, putting the fee-financed FDIC in financial
stress. Yet the Fed raised the discount rate to 0.75% on February 19,
2010. In contrast, in the five years prior to 2008, only 11 banks had
failed from the debt bubble even when the discount rate stayed within
a range from 2% to 6.25%.
Volcker, the Fearless Slayer of the Inflation Dragon
In the 1980s, to counter stagflation in the US economy, the Fed under
Paul Volcker, (August 6, 1979 – August 11, 1987), fearless slayer of
the inflation dragon, kept discount rate in the double digit range
from July 20, 1979 to August 27 1982, peaking at 14% on May 4, 1981.
>From August 1982 to its peak in August 1987, the Dow Jones Industrial
Average (DJIA) grew from 776 to 2722. The rise in market indices for
the 19 largest markets in the world averaged 296 percent during this
Volcker, as chairman of the Fed before Greenspan, caused a
“double-dip” recession in 1979-80 and 1981-82 to cure double-digit
inflation, in the process bringing the unemployment rate into double
digits for the first time since 1940. Volcker then piloted the economy
through its slow long recovery that ended with the 1987 crash. To his
credit, Volcker did manage to bring unemployment below 5.5%, half a
point lower than during the 1978-79 boom, and the acknowledged
structural unemployment rate of 6%.
Two months after Volcker left the Fed, to be succeeded by Alan
Greenspan, the high interest rate left by Volcker, inter alia, led to
Black Monday, October 19, 1987, when stock markets around the world
crashed mercilessly, beginning in Hong Kong, spreading west to Tokyo
and Europe as markets opened across global time zones, hitting New
York only after markets in other time zones had already declined by a
significant margin. The DJIA dropped 22.61%, by 508 points, to 1738.74
on Black Monday 1987. On October 11, 2007, the DJIA hit a high of
14198.10. On March 2, 2009, it lost almost 300 points, or 4.2%, to end
at 6763.29, its lowest point since April 25, 1997.
By the end of October, 1987, stock markets in Hong Kong had fallen
45.8%, Australia 41.8%, New Zealand 60%, Spain 31%, the United Kingdom
26.4%, the United States 22.68%, and Canada 22.5%. Fundamental
assumptions such as market fundamentalism, efficient market hypothesis
and market equilibrium were challenged by events. Despite that dismal
record in the 1980s, Volcker was appointed by President Obama two
decades later as first Chair of the President's Economic Recovery
Advisory Board on February 6, 2009.
The 1987 stock-market crash was unleashed by the sudden collapse of
the safety dam of portfolio insurance, a hedging strategy made
possible by the new option pricing theory advanced by Nobel laureates
Robert C Merton and Myron S Scholes. Institutional investors found it
possible to manage risk better by protecting their portfolios from
unexpected losses with positions in stock-index futures. Any fall in
stock prices could be compensated by selling futures bought when stock
prices were higher.
This strategy, while operative for each individual portfolio, actually
caused the entire market to collapse from the dynamics of automatic
herd-selling of futures. Investors could afford to take greater risks
in rising markets because portfolio insurance offered a disciplined
way of avoiding risk in declines, albeit only individually. But the
reduction in individual risk was achieved by an increase in systemic
As some portfolio insurers sold and market prices fell precipitously,
the computer programs of other insurers then triggered further sales,
causing further declines that in turn caused the first group of
insurers to sell even more shares and so on, in a high-speed downward
spiral. This in turn electronically generated other computer driven
sell orders from the same sources, and the market experienced a
computer-generated meltdown at high speed.
The Unlearned Lesson of the 1987 Crash
The 1987 crash provided clear empirical evidence of the structural
flaw in market fundamentalism, which is the belief that the optimum
common welfare is only achievable through a market equilibrium created
by the effect of countless individual decisions of all market
participants each seeking to maximize his own private gain through the
efficient market hypothesis, and that such market equilibrium should
not be distorted by any collective measures in the name of the common
good or systemic stability.
Aggregate individual decisions and actions in unorganized unison can
and often do turn into systemic crises that are detrimental to the
common good. Unregulated free markets can quickly become failed
markets. Markets do not simply grow naturally after a spring rain.
Markets are artificial constructs designed collectively by key
participants who agree to play by certain rules. All markets are
planned with the aim of eliminating any characteristic of being free
for all operations. Free market is as much a fantasy as free love.
In response to the 1987 crash, the US Federal Reserve under its newly
installed chairman, Alan Greenspan, with merely nine weeks in the
powerful office, immediately flooded the banking system with new
reserves, by having the Fed Open Market Committee (FOMC) buy massive
quantities of government securities from the repo market. He announced
the day after the crash that the Fed would “serve as a source of
liquidity to support the economic and financial system.” Greenspan
created $12 billion of new bank reserves by buying up government
securities from the market, the proceeds from which would enter the
The $12 billion injection of "high-power money" in one day caused the
Fed funds rate to fall by 75 basis points and halted the financial
panic, though it did not cure the financial problem, which caused the
US economy to plunge into a recession that persisted for five
subsequent years. Worst of all, the monetarist cure for systemic
collapse put the financial world in a pattern of crisis every decade:
the 1987 crash, the 1997 Asian financial crisis and the financial
crisis of 2007.
High-power money injected into the banking system enables banks to
create more bank money through multiple credit-recycling, lending
repeatedly the same funds minus the amount of required bank reserves
at each turn. At a 10% reserve requirement, $12 billion of new
high-power money could generate in theory up to $120 billion of new
bank money in the form of recycled bank loans from new deposits by
The Brady Commission investigation of the 1987 crash showed that on
October 19, 1987, portfolio insurance trades in S&P 500 Index futures
and New York Exchange stocks that crashed the market amounted to only
$6 billion by a few large traders, out of a market trading total of
$42 billion. The Fed’s injection of $120 billion was three times the
market trading total and 20 times the trades executed by portfolio
Yet post-mortem analyses of the 1987 crash suggest that though
portfolio insurance strategies were designed to be
interest-rate-neutral, the declining Fed funds rate was actually
causing financial firms that used these strategies globally to lose
money from exchange-rate effects. The belated awareness of this effect
caused many institutions that had not understood the full dynamics of
the strategies to shut down their previously highly profitable bond
The Rise of Hedge Funds
This move later led to the migratory birth of new, stand-alone hedge
funds such as Long Term Capital Management (LTCM), which continued to
apply similar highly leveraged strategies for spectacular trading
profit of more than 70% returns on equity that eventual led it to the
edge of insolvency when Russia unexpectedly defaulted on its dollar
bonds in the summer of 1998. The Fed had to orchestrate a
private-sector creditor bailout of LTCM to limit systemic damage to
the financial markets. The net effect was to extend the liquidity
bubble further – causing it to migrate from a distressed sector to a
The 1987 crash reflected a stock-market bubble burst the liquidity
cure for which led to a property bubble that, when it also burst, in
turn caused the savings-and-loan (S&L) crisis.
While the 1987 crash was technically induced by program trading, the
falling dollar was also a major factor. Although the dollar had
started to decline in exchange value by late February, 1985 due to US
fiscal deficit, that decline had yet to reduce the US trade deficit,
causing protectionist sentiment in the US to mount as the trade
deficit swelled to an annual rate of $120 billion in the summer of
The Issue of Exchange Rates
In part to deflect protectionist legislation, US officials arranged a
meeting of G-5 officials at the Plaza Hotel in New York on September
22, 1985 with the purpose of ratifying an initiative to bring about an
orderly decline in the dollar, observing that “recent shifts in
fundamental economic conditions among their countries, together with
policy commitments for the future, have not been fully reflected in
exchange markets,” and concluded that “further orderly appreciation of
the main non-dollar currencies against the dollar is desirable,” and
that the G5 members “stand ready to cooperate more closely to
encourage this.” During the seven weeks following the Plaza Accord,
G-5 authorities sold nearly $9 billion, of which the US sold $3.3
billion for other currencies, while speculators profited by shorting
The dollar had declined to seven-year lows in early 1987 amid signs of
weakness in the US economy while the US trade deficit continued to
grow. Demand was sustained not by income but by debt. Public
statements by Reagan Administration officials were interpreted in
exchange markets as indicating a lack of official concern about the
ramifications of further declines in the dollar.
On February 22, 1987, officials of the G5 plus Canada and Italy met at
the Louvre in Paris to announce that the dollar had fallen enough. But
despite heavy intervention purchases of dollars following the Louvre
Accord, the dollar continued to decline, particularly against the yen.
Market participants perceived delays in the implementation of
expansionary fiscal measures in Japan expected after the Louvre Accord
and talks of trade sanctions on some Japanese products heightened
concern about tension in US-Japanese trade relations.
Following the Louvre Accord, the G-7 authorities intervened heavily in
support of the dollar throughout the episodes of dollar weakness in
1987, and sold dollars on several occasions when the dollar
strengthened significantly. Net official dollar purchases by the G-7
and other major central banks effectively financed more than
two-thirds of the $144 billion US current account deficit in 1987. The
US share of these purchases was $8.5 billion, and the share of the
other G-7 countries was $82 billion, since the non-dollar
export-dependent governments wanted desperately to halt the
appreciation of their currencies.
Record US trade deficits and market perceptions that the G-7
authorities were pursuing monetary measures best suited to their own
separate domestic economic objectives soon sparked a further sell-off
of the dollar. This contributed to a worldwide collapse of equity
prices which had risen to levels unsupported by fundamentals. The
dollar’s decline gathered new momentum when the Federal Reserve under
its new chairman Alan Greenspan moved more aggressively than its
foreign counterparts to supply liquidity in the aftermath of the 1987
stock market crash which had been triggered by program trading on
portfolio insurance derivatives arbitraging on macroeconomic
instability in exchange rates and interest rates.
Domestic Accommodative Monetary Stance and Exchange Rates
The Federal Reserve’s actions under Greenspan in 1987 led market
participants to conclude that the Fed would emphasize domestic market
objectives with accommodative monetary stance, if necessary at the
cost of a further decline in the dollar. By year-end, the dollar's
value had fallen 21% against the yen and 14% against the mark from its
levels at the time of the Louvre Accord while Greenspan, the wizard of
bubble-land, was on his way to being hailed as the greatest central
banker in history. Two decades later, by 2007, the Greenspan put was
called by the market and trillions of dollars were lost.
The Issue of Unemployment
Half a century before 1987, beginning in 1921, deflation had descended
on the US economy like a perfect storm from Fed tight monetary policy
under Chairman Daniel R. Grissinger, with farm commodity prices
falling 50% from their 1920 peak, throwing farmers into mass
bankruptcies. Business activity fell by one-third; manufacturing
output fell by 42%; unemployment rose fivefold to 11.9%, adding 4
million to the jobless count.
Since mid-2007, the US has lost over 6 million jobs, with 4.4 million
jobs lost in the first year of the Obama administration. Latest
government estimate puts the Great Recession of 2008 as having lost
8.4 million jobs thus far and no more than 1.4 million jobs are
expected to be restored by the end of 2010. Unemployment is expected
to stay near double digit for the foreseeable future. If workers who
have given up looking for work are also counted, the unemployment rate
is close to 14% in 2010.
Some are attempting to put a positive spin on US jobs numbers for
February 2010 when the unemployment rate, though still at 9.7%, held
steady. The economy shed 36,000 jobs in January, but the good news was
that the pace of job loss was moderating. An average of 27,000 jobs
was lost each month since November 2009, compared with 727,000 jobs a
month on average over the same period in 2008. When the laws of
gravity says what goes up must eventually come down, there is no law
that say what goes down will eventually come back up. That is how
swimmers get drown; they float back up only after life has long left
the body. Only dead bodies float naturally.
While the unemployment rate is rising more slowly, it seems likely to
remain high. And despite the recent policy insistence that the top
three priorities are jobs, jobs and jobs, both Congress and the Obama
administration are not taking concrete steps to create them quickly
beyond the usual lukewarm tax incentives.
By February 2010, 8.4 million jobs have been lost since the financial
crisis began in July 2007. The normal 2.7 million jobs needed to
absorb new workers coming into the economy were never created, leaving
the economy bereft of 11.1 million jobs. To fill that cumulative
employment gap while keeping a growing work force fully employed would
require more than 400,000 new jobs a month for the next three years,
considerably in excess of even the most optimistic projections under
current job creation policies and programs. Further, healthcare
reform, if it is expected to save cost, will inevitably include a
reduction of jobs.
Five states reported new highs for joblessness in January 2010:
California, at 12.5%; South Carolina, 12.6%; Florida, 11.9%; North
Carolina, 11.1%; and Georgia, 10.4%. Michigan’s unemployment rate is
still the nation’s highest, at 14.3%, followed by Nevada with 13% and
Rhode Island at 12.7%. South Carolina and California rounded out the
Employers are unlikely to make new hires until they can profitably
restore their current part-time work force to full time. In the
private sector, just restoring hours cut during the recession will
neutralize the equivalent of 2.8 million new jobs.
Congress is taking its time debating an undersized jobs bill that is
not expected to create anywhere near the jobs that the economy needs
in 2010. The good news is that during the second half of 2010, the
economy will get a temporary, one-time job boost from the taking of
the census, which will hire about one million minimum wage temporary
workers. The danger is that misleading job statistics will allow both
the Administration and Congress to avoid meaningful job creation
commitments needed for a genuine recovery. Going forward, a jobless
recovery has become a given when the recovery finally comes.
The US, with a working population of 131,456,000 as of June 2010 out
of a total population of 307,000,000, had 14,600,000 workers
unemployed, yielding an unemployment rate of 9.5%. But Unemployment
is not equally shared among all worker types. Among teenagers it was
25.7%, among blacks was 15.4%, among Hispanics 12.4%, among whites
8.6% and among Asians 7.7%.
In July, US jobless rate held steady at 9.5%, while the government's
broader measure of unemployment was also unchanged at 16.5%. The
comprehensive gauge of labor under utilization, known as the “U-6” for
its data classification by the Labor Department, measures people who
have stopped looking for work or who cannot find full-time jobs.
Both rates held steady despite a drop in the number of people who are
employed. The number of unemployed people in the work force dropped,
but that was more than offset by a decline in the overall size of the
work force still looking for work. Though more people were no longer
in the labor force, fewer of those dropouts said they were currently
looking for work. This helped keep the broader rate steady.
The labor force data were affected by a temporary end to extended
unemployment benefits. The Labor Department survey was conducted
before the Senate expanded an extended-jobless-benefits program
through the end of 2010. Beginning in August 2010 many of those people
who dropped out of the labor force in the previous two months may
return to active job seeking. If the number of jobs created remains as
muted as it has been the previous few months, it could send both
unemployment rates higher.
The battle over the extension of unemployment benefits in the Senate
may be setting the stage for more bruising fights in the
not-too-distant future. Lawmakers on July 21, 2010 voted to continue
eligibility for extended unemployment benefits through late in the
year. But if history is any guide, there will likely be at least one
more call for an extension.
Meanwhile, the legislation allows job seekers to receive unemployment
benefits for up to 99 weeks, depending on their state of residence. In
the coming months, the number of recipients who remain unemployed
beyond 99 weeks could increase substantially.
According to an analysis by Goldman Sachs economist Alec Phillips,
unemployment benefits are extended an average of 23 months following
the peak in unemployment rate. In the current downturn, the peak in
the jobless rate — 10.1% — came in October 2009. To reach the average,
unemployment benefits would need to be extended through September
2011, which would require another act of Congress.
Meanwhile, that extension would just cover the average. In past
recessions, unemployment extensions continued until the unemployment
rate dropped below 7.5%. That’s a big two percentage points from the
9.5% rate recorded in June. Indeed, economists in the latest Wall
Street Journal forecasting survey see the rate still elevated at 8.6%
in December 2011. With 53% of people who start unemployment remaining
unemployed through at least the first 26 weeks — the highest level
since records began in 1972 — it’s going to take a long time before
the unemployment system returns to something resembling normal.
At the same time, the ranks of those who have exhausted all 99 weeks
of state and local benefits could be set to grow substantially. Most
of those facing the 99-week deadline would be counted in the Labor
Department’s tally of people collecting joint state-federal extended
benefits. That number has hovered around half a million in the June
and July 2010, but could be set to grow. Before benefits expired in
June when the Senate first failed to pass the benefits legislation,
more than five million people were collecting some kind of extended
unemployment insurance. Meanwhile, the Labor Department reported in
June that 4.3 million Americans have been out of work for more than 52
Even if most of the long-term unemployed could find jobs before they
reach the 99-week threshold, the number of people bumping up against
the 99-week ceiling could be set to rise substantially. One key reason
is the state of the job market 99 weeks ago (August 2008), as the
Lehman Brothers bankruptcy took place in September 2008 after which
the true hemorrhaging in jobs began. From January through August 2008,
the economy shed 1.2 million jobs total. In just four months the total
had jumped to 3.6 million, on its way to an 8.4 million total by the
end of 2009. The extension of jobless benefits in Jul 1010 gave job
seekers collecting benefits a reason to breathe slightly easier, but
there may be more squeezes ahead.
The 9.5% unemployment rate is calculated based on people who are
without jobs, who are available to work and who have actively sought
work in the prior four weeks. The “actively looking for work”
definition is fairly broad, including people who contacted an
employer, employment agency, job center or friends; sent out resumes
or filled out applications; or answered or placed ads, among other
things. The rate is calculated by dividing that number by the total
number of people in the labor force.
The U-6 figure includes everyone in the official rate plus “marginally
attached workers” — those who are neither working nor looking for
work, but say they want a job and have looked for work recently; and
people who are employed part-time for economic reasons, meaning they
want full-time work but took a part-time schedule instead because
that’s all they could find.
Both the headline and U-6 rates are based on the number of people in
the labor force. When the unemployed drop out of the labor force
completely the jobless rate declines. That problem has been
exacerbated in the current recession by the large number of people
unemployed for a long period of time. About 6.6 million people have
been out of a job for more than 27 weeks.
The government’s mid-2010 report on the job market was bleak, a sign
the economic recovery is running out of steam with 14.6 million
Americans still searching for work. Job growth proved anemic in July
as governments cut jobs and private-sector employers barely expanded.
The US economy shed 131,000 jobs, as 143,000 temporary Census workers
fell off federal payrolls. Private-sector employment grew by 71,000 in
July after a downwardly revised 31,000 in June. Government employment,
not counting Census workers, fell by 59,000.
The unemployment rate held steady at 9.5% largely because people gave
up hope of finding work and left the labor force.
The latest figures confirm the labor market has lost much of its
momentum in recent months. The private sector has added 90,000 jobs a
month on average so far this year, well below the 125,000 needed
monthly just to keep up with population growth, let alone recover the
eight million jobs lost during the recession. Two-thirds of the
private-sector job creation this year occurred in March and April,
when the economy’s trajectory appeared stronger.
The disappointing data initially sent the Dow Jones Industrial Average
down 160 points, but it recovered to end the day off 21 points to
10,653.56. Surging demand for safe U.S. government debt pushed the
10-year Treasury yield down to 2.82 percent, its lowest level since
April 2009. The two-year note fell to 0.514 percent after falling to
an all-time low of 0.494 percent during the day.
The labor market report compounds pressure on Congress, the White
House and the Federal Reserve to do something to reignite stronger
growth in the labor market.
At their policy meeting Tuesday, Fed officials plan to discuss whether
to take the small but symbolically important step of reinvesting
proceeds from its portfolio of mortgage-backed securities to maintain
support for the economy. The weak jobs numbers add to the case for
taking action, though officials must assess whether taking even a tiny
step could create expectations for larger actions in coming months.
Even in expanding sectors, many employers remain wary of adding jobs
without strong evidence the economy won't take another turn downward.
The jobs report showed private-sector employers working their
employees longer rather than hiring new ones. Aggregate weekly hours
worked rose 0.3% overall, and 0.5% in manufacturing.
Temporary-help jobs, typically a leading indicator for the rest of the
labor market, fell in July. Temporary employment declined 5,600 after
nine straight months of growth.
A weak labor market will keep incomes—and consumer spending, which
accounts for 70% of U.S. economic output—under pressure. The Fed said
on July 30 that consumer credit declined at a 0.7% annual rate in June
as consumers continued to pay down debt. Revolving credit, mostly
credit-card borrowing, fell at a 6.5% rate. About 6.6 million people
were jobless for more than 27 weeks in July, accounting for 44.9% of
all unemployed. Workers who are finding positions after long searches
are taking pay cuts to make ends meet.
The retail sector was among the areas to add jobs in July, increasing by 7,000.
Health care added 27,000 jobs while manufacturing rose 36,000.
Construction declined by 11,000.
Public Sector Layoffs
State and local governments shed 48,000 jobs, the most since July
2009, as many governments started new fiscal years that required them
to cut budgets. Lawmakers in Washington are set to clear a $26 billion
package to aid state governments, but that will only make a small dent
in the longer-run problem facing governments. In July 2010, cities
from Los Angeles, California to Dallas, Texas, to Trenton, New Jersey
either laid off workers or announced job cuts in their new fiscal
State and local governments shed 48,000 jobs in July, 2010, the
biggest drop in a year and almost double last month’s drop. State and
local government have cut a combined 169,000 jobs in the first half of
2010, including 102,000 over the second quarter. The latest report
suggests job losses could continue to accelerate as states grapple
with weak tax revenues and the loss of federal budget support in the
second half of 2010l. July is the first month of most states’ 2011
fiscal year, so the month’s job losses reflect budget decisions that
were made months ago but don’t translate to job losses until the
fiscal year turns on July 1, 2010.
Local governments shed 38,000 jobs in July 2010. States cut 10,000.
Local government — everything from cities to school boards and
transportation districts — account for 14.3 million jobs, compared
with 5.1 million for states. More people work in local government than
in the entire manufacturing sector.
State governments had expected tax collections to rise in 2010 as
their tax collections get a lift from tax increases and a slowly
improving economy. The first half of 2010 turned out to be a huge
disappointment. But even if the second half of 2010 turns out to be
the trough for tax collections, governments are likely to continue
cutting jobs for at least a few more months.
Budget assistance provided in the federal stimulus act is already
starting to run out, and after widespread tax increases last year,
legislators have preferred to balance this year’s budgets (delivered
in an election year) with cuts.
State governments saw year-over-year tax collections rise in the first
quarter for the first time since the outset of the recession, but
revenues were well below pre-recession levels for most states.
State tax revenues increased 2.5% to $164.5 billion in the quarter,
according to an analysis of Census Bureau data released Tuesday by the
Nelson A. Rockefeller Institute of Government at the State University
of New York. The Institute report said data from 42 states that have
released tax figures for April and May suggested that second-quarter
revenues grew less than 1%. “Fiscal conditions remain fragile,
indicating a long and bumpy road for recovery,” says Lucy Dadayan,
senior policy analyst at the Rockefeller institute.
The first-quarter gain was largely the result of tax increases, driven
by a 2.5% gain in personal income taxes and a 0.4% increase in sales
taxes. Corporate income taxes, which tend to be volatile, fell 0.6%
from a year ago.
Changes in tax revenues tend to lag behind recessions because it takes
time for lost wages and thriftier spending to translate into lower
income and sales taxes. Despite the recent improvement, state revenues
are still under heavy stress. The $164.5 billion collected in the
first three months of the year was lower than the tally in the first
quarter of 2006, about a year before the recession began.
While tax revenues have recovered from a free-fall that persisted
through much of 2008 and 2009, state budgets remain far from healthy.
Much of the first-quarter increase came from two states, California
and New York, that have raised taxes to close budget gaps.
While states have seen modest tax growth, local-government revenues
have just started to fall. Census figures show that property-tax
revenues—the lion's share of them collected by local governments such
as cities and school boards—fell 0.6% to $107.7 billion in the first
quarter from the same period a year ago. That was the first
year-over-year decrease in property taxes since the second quarter of
With tax revenues still lagging and the phasing out of state
assistance that was part of the $787 billion federal economic stimulus
plan, state budgets are expected to be under strain for several years.
A recent report from the National Governors Association showed states
still faced $127 billion in budget gaps over the next two years.
Unlike last year, current deficits have been mostly rectified through
program cuts instead of tax increases.
The Federal government has added support to state budgets, with the
Senate passing a bill that gives $26 billion to state and local
governments. The government is also expected to extend state Medicaid
support through part of 2011. Despite the new aid package, total
federal aid to state and local governments will be substantially less
than it was in the height of the stimulus. Still, states that have
released forecasts for their 2012 and 2013 fiscal years face
cumulative deficits estimated at $136.4 billion, according to a recent
report by the National Conference of State Legislatures (NCSL). With
stimulus funds ending and growing uncertainty about the economic
recovery, the NCSL report said, fiscal 2011 “may turn out to be the
calm before the fiscal tempest.”
State and local governments shed 48,000 jobs, the most since July
2009, as many governments started new fiscal years that required them
to cut budgets. Lawmakers in Washington are set to clear a $26 billion
package to aid state governments, but that will only make a small dent
in the longer-run problem facing governments. In July 2010, cities
from Los Angeles, California to Dallas, Texas, to Trenton, New Jersey
either laid-off workers or announced job cuts in their new fiscal
The House of Representatives passed a bill on August 10, 2010
providing $26.1 billion to aid deficit-stricken state governments, and
preventing some 161,000 teachers and 158,000 public works employees
from being laid off nationwide. The vote was 247-161 along partisan
lines with Democrats for and Republican against. President Obama
immediately signed the bill into law.
Democratic lawmakers pushed hard o pass the state aid legislation
before the start of the school year in hope of better results for
incumbents facing November mid-term elections.
Representative Barney Frank (D-Mass.) told the press: “The frustration
of course has been that the Republicans have a two-step strategy:
First of all, obstruct anything from getting better, and then point
out that things aren't getting better. I mean the bill that's being
passed today, if it were passed a month ago, we wouldn't have had the
[Labor Department Bureau of Labor Statistics] job loss report last
week and I think they [Republicans] are fine with that.”
Technically, the bill provides $10 billion to fund education and $16
billion to fund Medicaid. However, many states have been expecting to
get the federal assistance and a majority have already budgeted for it
by July 1, 2010. This means that that if the funds were blocked, cuts
would have to be made elsewhere – laying off firefighters, police
officers and other state employees. The House was already in recess on
August 5 when the Senate passed the jobs bill. But lawmakers were more
than willing to sacrifice a couple of days at home in their districts
to get the bill passed, according to Frank who supports the bill.
Many of the jobs protected under this bill belong to teacher unions or
the American Federation of State, County and Municipal Employees, both
key parts of the Democrats' political base. But the case for action
has an economic basis: Forcing layoffs at the state level counteracts
federal stimulant efforts and could push the economy toward a
double-dip recession. And laying off state workers, only to have them
receive state unemployment checks, makes little fiscal sense.
The next unemployment trouble will come from the public sector.
Without timely and adequate Federal aid, the states and local
governments will be forced by falling tax revenue to tighten fiscal
budgets, which will mean layoffs and cancelled private contracts, both
of which would squeeze demand in the private sector to further reduce
local government revenue in a downward spiral.
The full article
Thus a sound fiscal policy does not automatically mean a balanced
fiscal budget even in the long run. The current mantra on fiscal
austerity adds up to a poor fiscal policy.
July 30, 2010
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