In July 2008, in a memorandum for the Obama campaign team and later published in Challenge, I wrote as follows:
If the above analysis is correct, the political capital of the new presidency risks being depleted, quite quickly, in a series of short-term stimulus efforts that will do little more than buoy the economy for a few months each. Since they will not lead to a revival of private credit, every one of those efforts will ultimately be seen as “too little, too late” and therefore as ending in failure.
Painful though it is to repeat those words, the question remains: what can be done now?
1. First of all, do not rely on the Federal Reserve. Quantitative easing is eyewash – a fantasy solution. And the zero interest policy is also not expansionary. These policies relieve banks of bad assets, provide them with cheap funds, and make them seem profitable in spite of the fact that they are doing nothing constructive. They do not increase lending to the public and therefore have no effect on spending. Further, the zero interest rate policy reduces total spending, since it cuts interest incomes and therefore spending from interest income.
Eventually the short-term interest rate should be raised, and banks “jawboned” to raise the interest rates they pay on deposits and CDs. This is an expansionary policy under appropriate conditions:it squeezes bank profits and encourages them to take more business risk. As in 1994, banks that are truly solvent will seek to keep their earnings up by making commercial and industrial loans – the legitimate risk-taking that powers the private economy.
2. As for the banks that are not truly solvent, who needs them? They are a burden, kept alive by the raw exercise of political power. It is past time for clean audits, for definitive market valuation of toxic assets, and for the downsizing of bloated banks, under new top managers – paid appropriately less than the current crop. Meanwhile we need full investigation and prosecution of the vast swindles in the mortgage markets.
3. Restructure household debts. Restoring financial health to households will be a long, slow process, but it must start. Let’s have a new bankruptcy reform ending the indentured servitude imposed under Bush, and also enact the right of judges to cram down mortgage payments in bankruptcy. Let’s enact right-to-rent for foreclosed homeowners, and direct Fannie Mae and Freddie Mac to reset and restructure mortgage payments aggressively.
4. Let people retire! Full employment is the right goal but job losses have been so severe that practically we are not going to get there by any known measures. So we need to choose who gets the first crack. The right thing is to allow older workers who wish to exit the labor force to do so, opening jobs for younger people. Enact a three-year window during which workers aged 62 and older could retire on full Social Security. Enact Medicare at 55, allowing workers with health problems but sufficient resources otherwise to escape into a comfortable retirement.
5. Help the States. So far, help for states in the stimulus program has only offset the job cuts imposed by falling revenues and balanced-budget requirements. There must now be fiscal assistance to end, finally, the budget crisis of states and localities. Federalizing Medicaid may be the most effective and practical way to achieve this. The alternative is open-ended general revenue sharing: on the condition that states neither raise nor lower their tax rates, the federal government should supply the funds required to close their budget gaps and to maintain public services at baseline levels, for the duration of the crisis.
And if deficit hysteria could be overcome, the following steps should also be taken:
6. Tax relief for workers. The American Recovery and Reinvestment Act (ARRA) offset payroll taxes through the income tax. This policy should be extended, expanded, or even altogether replaced by a full payroll tax holiday, granting all working families an increase in after-tax incomes of over eight percent up to the limit of the FICA. To keep the Social Security Trust Fund whole, let the federal government credit it for the taxes — and add the revenues of the estate tax for good measure. The policy of tax relief for workers should remain in place until unemployment falls below six percent, at which time it can be gradually phased out. Tax relief for the wealthy is a failed strategy that should end now; a higher personal tax rate will induce companies to retain and invest their earnings, as they used to do.
7. Jobs Programs. Taking a leaf from the New Deal, let the federal government establish a new Conservation Corps, a Neighborhood Corps to protect, maintain and revitalize (or as necessary demolish) distressed housing, and a Home Care corps to provide services to the elderly in their own homes. Other suggestions welcome.
8. Strategic Investments: Energy and Climate Change. The illusion of stimulus was that the economy would “return to normal” with a little “fiscal boost.” The reality is that having exhausted (however imperfectly) the 1940s agenda of middle-class housing, the 1950s highways agenda, the 1960s health-care agenda and the 1990s information-technology bubble, the economy needs a new strategic direction. The clear and pressing priorities are energy and climate change. To address these challenges is a grand task, requiring decades of research, careful planning and many investments, if we are to pass on a livable planet and a decent living standard. Institutionally it will require new lending agencies to assure that the funds needed are available over the long term. And the work can provide jobs for millions, for many years.