No More False Choices: Christina Romer on Fiscal vs. Housing Policy

Sep 27, 2011Mike Konczal

Romer refuted four of the most popular objections to President Obama's jobs plan. Any other takers?

Christina Romer wrote an excellent New York Times article on Sunday, "A Plan on Jobs Deserves a Hearing." In it, Romer discusses four objections to the new Obama jobs plan. In keeping with developing a map of demand and supply explanations for the weak economy, I want to specifically address how Romer discusses the different demand-side approaches. First, let's take another look at that demand-side map:

Romer argues for the job plan, which is centered around solutions in the fiscal circle (infrastructure, tax cuts) and doesn't primarily include solutions in the housing circle (except for housing refinancing, which is unlikely to go anywhere). Romer addresses this head-on:

WE NEED A HOUSING PLAN, NOT MORE FISCAL STIMULUS The bubble and bust in house prices has left households burdened with too much debt. Until we deal with this problem — perhaps by providing principal relief to the 11 million households whose mortgages are larger than the current value of their homes — we’ll never get the economy going.

The premise of this argument is probably true: recent evidence suggests that high debt is holding back consumer demand. But it doesn’t follow that the government needs to directly lower debt burdens to stimulate job growth.

Recent research shows that government spending on infrastructure or other investments raises demand even in an economy beset by over-indebted consumers. Another effective approach is to aim tax cuts and government payments at households that would like to spend, but can’t borrow because of their debt loads (such as the poor and the unemployed).

History actually suggests that the “tackle housing first” crowd may have the direction of causation backwards. In the recovery from the Great Depression, economic growth, which raised incomes and asset prices, played a big role in lowering debt burdens. I strongly suspect that fiscal stimulus will be more cost effective at speeding deleveraging and recovery than government-paid policies aimed directly at reducing debt.

We should, however, be thinking hard about whether the president’s stimulus plan is the best one for a debt-heavy economy. It may be too tilted toward broad tax cuts, when bigger increases in government investment spending and more targeted tax cuts would promote faster growth.

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I tend to think there's enough space for advancement on all three fronts, especially as they are three distinct battlefields -- Congress and budgets for fiscal, the FOMC and expectations for monetary policy, and regulators and the foreclosure industry for housing. If all three approaches had to go through one place I could understand the need to pick our battles, but they exist in different spaces with different arguments. As such, I've always thought liberals need to take them all on at once.

But in general, those who think that we have a housing debt hangover think that running a larger fiscal deficit is a good thing. This is a representative argument: "If the private sector is incapable of absorbing all desired savings the government has to jump in – at least temporarily, while the private sector is paying down its excess debts. The government offers savers a safe asset (government bonds) and uses the funds to directly boost aggregate demand."

Or as Richard Koo puts it:

Indeed the key lesson from the Japanese experience is that fiscal support must be maintained for the entire duration of the private-sector deleveraging process. This is an extremely difficult task for a democracy in a peacetime, because when the economy begins to recover, well-meaning citizens who dislike reliance on government will argue that since fiscal pump-priming is clearly working, it is time to reduce (what they see as wasteful) government spending. But if the recovery is actually due to government spending and the private sector is still in balance-sheet-repair mode, premature fiscal

reform will invariably result in another meltdown, as the Japanese found out in 1997 and the Americans in 1937...

Although government deficit spending should be avoided when the private sector is healthy and forward looking, once in several decades when the private sector gets carried away in a bubble and damages its financial health, a prompt and sustained fiscal medicine from the government is essential in minimizing both the length of recession and the eventual bill to the taxpayers.

Romer adds an interesting argument to this overlap -- that the best way to deal with the housing hangover is to boost wages and employment, which can be done through fiscal policy. Unemployment is well-correlated with deleveraging, foreclosures and underwater mortgages, so relief through this channel will go toward the areas most in need. I'd add that even places where there wasn't a housing bubble -- say, Texas -- have very high unemployment rates in excess of 8 percent, indicating something larger at work than simple deleveraging.

I agree with what Romer hints at, that the job plans is too tilted towards tax cuts. Building in infrastructure will have a payout years down the road that will make this an even better investment, but with real interest rates negative we should be getting as much of it out the door as we can until output returns to trend.

With the Romer editorial in hand, what are the arguments against this job bill again?

Mike Konczal is a Fellow at the Roosevelt Institute.

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