COLUMN LEFT/ ROBERT POLLIN : Washington Must Spend to Spur Spending : A $60-billion boost would reverse cuts and instill the confidence the public needs.
The dismal economic news--that the unemployment rate rose from 7.5% to 7.8% nationally and from 8.7% to 9.8% in California between May and June, and that the state is now reduced to issuing IOUs--makes clear that recovery from the recession has been stalled, if not reversed. This recession, which began in July, 1990, was already the longest of the post-World War II period. Without dramatic policy actions to reverse the current trends, it will almost surely stretch into a third year.
There is only one policy capable of jolting the economy forward into a sustainable recovery. That is to increase federal spending without raising taxes--that is, increasing the federal deficit. The federal government should spend an additional $60 billion immediately, with the funds targeted at increasing federal revenue-sharing for state and local governments. This would reverse the savage and self-defeating cuts at the state and local level and promote a wide range of beneficial projects in the areas of infrastructure, education, child care and housing.
A reasonable argument can be made for reducing the federal deficit over the next several years. But deficit-reduction policies should be implemented during an economic upswing, not during the painful crawl out of recession.
The Federal Reserve mercifully dropped short-term interest rates a substantial one-half percentage point immediately following last month’s negative unemployment news. But Fed rate-cutting will not be enough to guarantee recovery. After all, the Fed has been dropping short-term rates steadily for the past two years. Short-term rates now rest at their lowest level in nearly 30 years.
Despite the low rates, businesses and households are reluctant to increase their borrowing because they are still carrying the burdens of the heavy debt built-ups of the 1980s. As business profits and household incomes have fallen during the recession, their ability to meet debt payment commitments has weakened. Households will therefore not pursue the bait of lower interest rates until their incomes rise enough for them to dig out of their already excessive debt obligations. Businesses also won’t borrow more, despite the lower rates, until they see customers with higher incomes and lower debt burdens, and thus more spending money.
Increasing federal deficit spending now is the only means available of getting more money into consumers’ pockets. The alternative of carrying out state and local government spending cuts--such as those Gov. Pete Wilson proposes for California--will only ensure a continued recession. As workers face layoffs or salary cuts and as private businesses lose state contracts, overall income in both the public and private sectors will fall. This means that household debt burdens will worsen, consumer spending will decline further, and tax revenues to the states--through income and sales taxes--will drop.
The federal government, through deficit spending, is alone capable of breaking this vicious cycle, since states like California are legally obligated to run balanced budgets. A $60-billion injection of federal deficit spending will initiate a “virtuous cycle” of rising incomes bringing lighter debt burdens, more tax revenues, and rising consumer and business confidence.
Moreover, since the government money will be targeted at important public investment projects, the increased spending will also promote long-term productivity and competitiveness, as well as produce the necessary short-term jolt. Deficit spending for public investment, in other words, provides a quick-fix remedy with long-term benefits.
Wall Street will of course howl in protest, claiming that increasing the deficit further will eat up the savings needed for private businesses. Long-term interest rates for private business would have to rise, according to Wall Street. Businesses will be unable to afford financing for their long-term investment projects, and this will stifle the recovery.
But there is no reason why the Federal Reserve could not counteract Wall Street’s efforts to raise interest rates after the federal deficit has increased. More important, since when have public officials abdicated to Wall Street the responsibility of setting economic policy? The best minds on Wall Street, after all, have triumphantly forecast 11 of the past five recessions. Over time, they have also demonstrated a remarkable capacity for misapprehending their own best interests. In the early 1930s under Herbert Hoover, Wall Street spoke as one voice: Balancing the federal budget was necessary for restoring economic prosperity. Hoover heeded their advice. Are we foolish enough to listen again?
