Unemployment

The idea at that point, with that enormous amount of money that was going to be spent on the stimulus, was, okay, this is going to bring back employment. You and [Council of Economic Advisers Chair Christina] Romer got in a little bit of trouble when you put out that report, which said that the stimulus would bring [unemployment below] 8 percent. …

The research that Christie Romer and I did early on was very much targeted at how many jobs we thought this amount of stimulus would generate, and how many points it would shave off of the increase in unemployment. We felt the stimulus would generate something in the neighborhood of 3 million jobs -- that is, either jobs that otherwise would have been laid off or create new ones. And we thought that it would subtract a couple of points from the increase in unemployment.

Now, it's not that we thought unemployment wouldn't go up; we knew it was going up. We thought it would go up maybe a couple of points less if the stimulus of the magnitude that we ultimately passed was successfully implemented.

What we clearly got wrong was the level of the unemployment rate. We used the consensus estimate among economists at the time, and that was too low, because few people really saw just how deep this downturn was going to be.

But what we actually got right is confirmed by, say, the nonpartisan Congressional Budget Office, was what economists call the delta, the difference between where things would have been and where things actually ended up. …

There's been a lot of criticism, to this day, that the president and the economic team was naïve, because we thought we'd be able to come back to the well for more stimulus measures if things were worse than we thought. …

I don't think anybody saw the extent of partisan rancor that exists now, even four years ago. A lot of this criticism is 20/20 hindsight. It never occurred to me that the minority leader in the Senate, Mitch McConnell, would say, "Our number one goal is to defeat the president," as opposed to, "Our number one goal is to bring down the unemployment rate," or something.

And you can say it's naive to think that after an $800 billion stimulus we wouldn't be able to come back for more. But I think that there's a lot of 20/20 hindsight on that particular kind of critique.

You were always worried about a jobless recovery, it seems.

Yes.

You had a briefing in June '09 with the president about this issue. What was that briefing like? What were you trying to tell the president about and sort of what it tells us about the way he would view a subject as important as this?

Certainly, the subtext was, "Sir, you can see that GDP is starting to recover, and that's obviously a good thing. But don't think that that's necessarily going to lead to the kind of job growth we need, to bring the unemployment rate down, to give people the opportunities we all agree that they need."

Of course, the subtext there is, we're going to need to do more. We're going to need to build on some of the momentum that the Recovery Act is having. It's working on the GDP side, but it's going to take more to translate that into real job growth.

And did he worry about that?

Yes.

Did he talk about the political realities?

Yes. … He gets this, but he also has to get the constraints, the reality, the budget deficit argument that's out there, the difficult politics. I mean, he's got people who claim that their main goal in life is to make sure he doesn't get re-elected. He faces some pretty steep constraints.

... There's a big meeting in December [2008], before he goes to the inauguration, where they decide on the stimulus number. ... How do they come to the numbers that they come to? Do they know that they maybe will only have one chance to do it? And do they get it right?

The issue of the size of the stimulus had been discussed with members of Congress very widely in the months even before the election. The basic issue was how weak was the economy? How large would the multipliers be? That is to say, for every dollar of stimulus, how much extra GDP would you get? How long was the downturn likely to be?

There were different views on all these questions. Those in the financial side, those who saw the problem as Lehman Brothers and thought that there was a little tremor to the economy, [said] you fix the banks, the economy goes back. They believe in free markets. Markets work well. We had a little bit of an accident. Let's not talk about too much in detail, but once we fix the banks, we're back and running.

From that perspective, all you needed is some short-term stimulus to tide you over until the banking system gets back to health. So you need a short-term, 18 months, 24 months, moderate in size. The normal restorative forces are pretty strong.

The other side saw the economy really facing a very severe problem. I was on the side of those who saw the economy facing a very severe problem, partly because I looked back at what the economy was before 2008. I thought the economy had been sick. I thought the economy had been on artificial respiration for several years, that the housing bubble had been keeping the economy going. You take away that artificial respiration and you have a problem. ...

What did you advise them as far as the stimulus?

... You would probably need 2 to 4 percent of GDP per year, ... [which] would be in the magnitude of $300 billion to $600 billion per year until it comes back. But that might not be enough given the severity of the problem.

We're filling a hole of consumption going down by 5 percent. We're filling a hole of investment in real estate going down. Who knows what's going to happen to the global economy? Trade figures had gone down more seriously than even in the Great Depression.

So the side here was on caution and that you needed to have a very, very big stimulus.

There's another side to this. The political side is saying, "What are you, nuts?" Why did they decide what they decide?

There was one more aspect to this, which was the design of the stimulus. Some kinds of [spending] have higher multipliers than others.

Unemployment insurance is a very good stimulus for two reasons: When you give people who are unemployed money, they spend it. Secondly, if there's no unemployment, you don't have to spend the money. You only spend it in tandem with the severity of the economic downturn. We call those automatic stabilizers. So that's a good way of stimulating the economy.

Tax cuts for rich people are very bad ways to stimulate the economy. They save a lot of it, and what they spend they often spend on vacations in Europe or someplace that doesn't stimulate the American economy.

Paying money to, say, Nepalese contractors working in Iraq doesn't stimulate the American economy. So the war spending was not very good for stimulating the economy today or obviously long-term economic growth.

What I saw as inevitable was the following: Unemployment was going to go up. States and localities are going to have tax revenues go down especially [because] many of them depend on property taxes. Property values had gone way down; they're not going to be able to raise taxes.

And they have a balanced budget framework, which means when the revenues go down, they cut back. That means you're going to be firing teachers, you're going to be firing healthcare workers, just at a time when we're going to need them even more.

So I said let's give a lot of money to the states and localities to make up for their shortfall caused by our bad macroeconomic performance in Washington. It's not their fault that the economy's going down; it's the fault of mismanagement in Washington, the Fed and the administration. So that was the second thing.

If we're going to give a tax cut, let's target to investment. Let's tell American corporations, if you invest in America, you'll get a tax cut. If you don't, your taxes are going to go up. So we provide incentives for more investment.

We didn't want to stimulate more consumption, because we've been overconsuming in America. That wasn't where we want to go.

If you had taken that kind of a program, it would have provided more stimulus per dollar spent and put us on a better course for the future. But that wasn't the direction that they took. What they did instead is basically say $800 billion over two years, Congress figure out where it goes.

What was the problem with telling Congress to do it?

They start compromising, and a third of it went to tax cuts, which didn't stimulate the economy very much. Some of it went to what they call shovel-ready investments that discredited the spending. It still stimulated the economy, but it discredited the program. ...

One of the things that has come out is [Obama senior adviser Pete] Rouse's memo in which he said that there was a problem in the economic team, that [National Economic Council Director Larry] Summers was heavy-handed, that talks of constant relitigation. Relitigation kept on coming up over and over again, causing delay in making decisive decisions. Did Rouse get it right?

I think Pete has a point, definitely, but it's been misunderstood as if Larry was somehow feet-dragging or delaying the process.

What was happening at that time was the economic team was largely thinking about the importance of another round of stimulus. And the political team was starting to wonder, is that something we can do at a time when this stuff isn't as beloved as you economists might want it to be among our public.

So what could have happened? What should have happened?

As an economist, I think we should have built on some of the momentum that was coming out of the Recovery Act. I suspect the unemployment rate would be considerably lower now if we had.

But there were very clear political constraints, particularly as we're moving up towards the midterm and after that, which was very much seen as a vote against government spending.

But then you've got the other side of it, which is the fact that Obama's being blamed now for the unemployment figures.

Right.

So did the political team get it wrong? Because the reality is maybe this is going to come back to bite them, and Obama could lose his job, specifically because of this point.

It's not up to the political team to say, "Here is what the unemployment rate will look like a few years from now, sir, if you take the economists' advice." It's up to them to tell the president how these policies are playing out in the minds of the electorate.

I think what was going on at that period where members of the team are being accused of argumentation and feet-dragging is more like we recognized that we needed another dose of stimulus to build on some of the momentum of the Recovery Act, which was already beginning to fade, while the politics were pushing in a very different direction.