Why are we always unprepared for recessions?
When the economy sputters, stimulus should kick in automatically
Snow in England
I lived in the UK for five years. Every winter, this would happen at least once: some snow would fall from the sky and the country would spiral into a panic. It was if they’d never seen it before. If more than an inch accumulated on the ground, trains would derail. Roads would become impassable as drivers plowed into each other. Schools would shut. And, even for a country that has a truly remarkable tolerance for small-talk about the weather, all anyone could talk about was the snow.
As a Canadian, I found this bewildering. At first I thought, hey—this isn’t Montreal—maybe it really doesn’t snow that often here. But nope, it does: it snowed heavily at least once every year I lived there (apparently London gets, on average, 16 days of snow every winter).
You’d think that they’d be used to it by now.
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Recessions in America
The British failure to prepare for snowstorms has been on my mind as I think about how the Biden administration has handled the economic fallout from the pandemic. Like Londoners peering out of their windows in awe on a snowy morning, our political leadership seems to greet every downturn as if we’ve never seen one before.
This time, as with the recession of 2008, Congress assembled a stimulus package in a hurry. It helped. But since the legislation was formulated in a panic as the economy crumbled, it was especially vulnerable to the partisan bickering and the pork-barrel compromises that it takes to get anything done in this country. As a result, the bulk of the stimulus ended being enacted too late, and on arrival was bloated, poorly-targeted, and possibly much too large.
How governments fight recessions
Governments use two tools to fight economic downturns.
The first is monetary policy: the central bank (the Federal Reserve, AKA “The Fed”) can engineer lower interest rates in the economy. Borrowing becomes cheaper, inducing companies to invest and households to buy more stuff. It’s like dialing up the volume on the whole economy.
But monetary policy can’t do much these days because interest rates are already close to zero. And low interest rates also seem to be one of the reasons that assets—from stocks, to crypto, to real estate—are soaring to what are likely unsustainable levels (fueling our already neo-feudal degree of inequality and leading to chaos when it all inevitably unravels).
This leaves the onus for fighting downturns on Congress and the tool at their disposal: fiscal policy.
Fiscal policy entails the government spending more—on items like unemployment insurance payments, Medicaid transfers to individual states, and infrastructure investments. The government can also lower taxes, which leaves more disposable income in the pockets of companies and households.
If monetary policy is pumping up the volume on the entire economy, fiscal policy is tweaking the dials—boosting parts that need it (like unemployed workers) while, in theory, leaving others untouched (like already-wealthy investors). The idea is that the money the government spends has a “multiplier effect” on the economy—for every dollar it spends, we can expect more than a dollar of economic activity. Most estimates place this multiplier around 1.6x:
But this tool relies on the finesse of politicians. The problem is, they don’t seem to have much of it.
Why politicians suck at managing economic downturns
There are a few reasons politicians have hard time calibrating the dials of government spending to the needs of the economy.
First, they’re too slow to act. Take the most recent, COVID-induced downturn as an example: although the Trump administration acted quickly to pass stimulus in March 2020, Congress didn’t pass some of the largest aid until March 2021—a full year after the WHO declared a global pandemic—and by which time it was probably merely fueling inflation.
Second, politicians make huge mistakes in sizing stimulus. This, I guess, shouldn’t be that surprising. Consider how the sausage is made: economists—who are fairly lousy at forecasting (see chart below)—predict how much of a jolt the economy needs. Then politicians craft legislation based on those lousy forecasts, adjusting up or down according to their ideological predispositions. It’s a poor foundation for legislation.
And that’s the mess that we start with before the political bickering begins.
Indeed, the third reason our leaders are horrible at cushioning economic downturns is that, in crafting legislation, there is too much political discretion and back-room negotiation around what should be a technocratic decision. Because time is critical, the administration can be blackmailed by individual representatives to add to the legislation various self-serving, pork-barrel measures. Senate minority leader Mitch McConnell, for example, insisted that COVID relief measures include the establishment of an independent commission to oversee horse-racing in Kentucky. He “feared for the future of horse racing and the impact on the industry, which of course is critical to Kentucky.” Sure, why not.
Aside from grubby politicians, there are also pesky voters to contend with. The degree to which political leaders calibrate economic aid to achieve the desired public opinion—rather than the right economic outcome—is staggering. Here is former President Obama describing how his administration sized the great recession stimulus (the American Reconstruction and Recovery Act) in his memoir “A Promised Land”:
So we needed a stimulus package. To deliver the necessary impact, how big did it need to be? Before the election, we’d proposed what was then considered an ambitious program of $175 billion. Immediately after the election, examining the worsening data, we had raised the number to $500 billion. The team now recommended something even bigger. Christy [Romer] mentioned a trillion dollars, causing Rahm [Emmanuel] to sputter like a cartoon character spitting out a bad meal.
“There’s no fucking way,” Rahm said. Given the public’s anger over the hundreds of billions of dollars already spent on the bank bailout, he said, any number that began “with a t” would be a nonstarter with lots of Democrats, not to mention Republicans. I turned to Joe, who nodded in ascent.
“What can we get passed?” I asked.
“Seven, maybe eight hundred billion, tops,” Rahm said. “And that’s a stretch.”
It may have been a stretch from a public opinion perspective, but it was not nearly enough from an economic one. What politicians and the public didn’t understand was that the economy was falling short of its potential by $80 billion per month.
All of these issues—poor forecasting, ideological biases, political negotiation, and concerns about public opinion—result in legislation that is rarely right-sized for the economic hole. Indeed, the Obama administration did way too little in 2009, and Biden is now (probably) doing way too much.
There is a better way: automatic stabilizers
It needn’t be this way. The government could enact a plan ahead of time: if economic indicators flash red, this would automatically trigger additional disbursement of federal money for, say, Medicaid, or SNAP (food stamps), or for topping up unemployment insurance and emergency unemployment compensation. These fiscal measures which would work on auto-pilot are called “automatic stabilizers”. Since they would, by design, be calibrated to the severity of the downturn, they would always be the right size. And since these measures would be crafted outside of times of crisis, they would be free of the bloat that emergency legislation tends to include.
To some extent, we already have them in place. Take tax collection, for example: since taxes are levied as a percent of income, they decrease automatically when incomes drop. Unemployment insurance works on this principle too: a rising unemployment rate triggers more federal spending on unemployment insurance.
The problem is that the automatic stabilizers that are already built into our system are far too small. This is in keeping with the approach to government in America—if government spending and revenue is a small part of the economy, then fiscal adjustments will not have a big impact on the economy. And that’s why, during every downturn, politicians scramble to pass emergency measures. They shouldn’t have to grab the controls—stimulus should be on auto pilot.
Setting this up isn’t a piece of cake, but neither is it rocket science. We would have to decide what kind of economic deterioration registers as a trigger for government aid. We would have to decide on the form of that aid.
But, there is so much low hanging fruit, too. Take the the individual states, for example: some of them have generous UI programs, and some have minuscule ones. There is an enormous amount of intra-country variation in needed support. Federal automatic stabilizers could take that into account, disbursing funding where it’s most needed.
And there is a problem that affects almost all states: the requirement, by law, to balance their budgets ever year. Not only are most states constrained from loosening the purse strings when times are tough, they often have to retrench services that are at least partially state-funded (like education and Medicaid), since they’re taking in less tax money. We could design automatic stabilizers that send federal money to states that face economic downturns but are stuck in balanced-budget straight-jackets.
Or take infrastructure projects. Many politicians on both sides of the aisle agree that we should take advantage of low interest rates and borrow money to invest in growth-boosting roads, bridges, trains, airports, and renewable energy projects. But most of these are not “shovel-ready”—they are not ready to go when an economic crisis hits. With fortified automatic stabilizers, we could draw up a list of shovel-ready projects, and when the economy turns down, disburse federal funds to those projects right away.
American exceptionalism is the way forward
The US is an outlier here: amongst wealthy countries, we have the smallest automatic stabilizers. And, unlike most countries, in the US most of the stabilization comes from taxes rather than social benefits. This makes our brand of stabilization both less egalitarian and less effective (since the poor spend more of any stimulus than the rich, and spending is exactly what you want in a downturn).
Most European countries have larger stabilizers as a byproduct of a larger state, not by design. But the US doesn’t have to follow suit; larger automatic stabilizers needn’t entail a permanently larger government. It actually seems like automatic stabilizers are a uniquely American approach—lean government in most times, and a larger one when when needed. In fact, to some extent this is what we are already doing, but with a lot more chaos than is necessary.
“A ton of resources are wasted during a really crucial time…just having to go through this ad-hoc stimulus and relief and recovery, and it doesn’t have to be like that”
-Heidi Shierholz, Senior Economist, Economic Policy Institute
And unlike most measures that entail government spending, this one appeals to at least some Republicans, too: automatic stabilizers would ensure government stimulus is not too large, and that it expires when the economy recovers. Polling shows that most Americans—of both parties—would be in support:
“The idea that more recession spending should be on autopilot rather than dependent on the whims of politicians seems to be a good one whether you’re a hawk or a dove”
-Marc Goldwein, SVP Committee for Responsible Budget
Why hasn’t this happened already?
The Biden administration introduced the idea of automatic stabilizers in its COVID relief package, but quietly dropped it somewhere along the way. It’s not the kind of flashy measure that will, say, boost a President’s dismal approval rating. But automatic stabilizers are what we need.
As the economic fallout from the pandemic recedes, the administration should set its sights on the next crisis. Just like snowstorms in England, economic crises are regular occurrences. Why don’t we prepare for them?