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The Why and What of a “Jobs Summit”

J. Bradford DeLong

Professor of Economics, U.C. Berkeley Research Associate, NBER

December 1, 2009

A year ago, in December 2008, the incoming Obama administration set its proposed macroeconomic policies at the 50th percentile mark: it took the midpoint of the then-distribution of possible outcomes, and calibrated its policies so that they would be appropriate for an economy that actually performed as was then expected—at the midpoint of the distribution of then-possible future outcomes. The policies envisaged an economy in which the current—December 2009—unemployment rate would be 7.8%, with the unemployment rate expected to decline to 6.9% by December 2010. But we do not live in that 50th-percentile-as-forecast-as-of-December-2008 world. We live in a world in which the unemployment rate this month is likely in the end to come in at 10.4%, and in which the unemployment rate in December 2010 is likely to be not 6.9% but 9.6%--or higher. It was clear as of the moment of the signing of the Obama ARRA on February 17, 2009 that we were not headed for the 50th-percentile 6.9% December 2010 unemployment world. (My forecast of December 2010 unemployment back last February was 8.5%.) But the High Politicians and High Spinmasters of the Obama administration last February did not acknowledge that the world we were moving forward into was different

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than the world we had expected. It is only now—December 2009—that President Obama is turning his attention back to the economy, and hosting a “jobs summit.” The problem is not that the policies as proposed by the Obama administration and has enacted by Congress have not performed as expected: they more-or-less have. The problem is that they were 50th percentile policies. And we find ourselves living, instead, in a 20th percentile world. Ever since the 1930s. economists trying to analyze the determinants of spending have focused their attention on two of the economy’s markets: the market for liquidity and the market for savings. The market for liquidity—the money market—is a market that matches the readily spendable purchasing power existing the economy (cash, checking account balances, credit lines) with households’ and businesses’ demands, given the level of interest rates and the flow of spending, to hold some of their wealth in the form of readily spendable purchasing power. The market for savings—usually called “the bond market”—is a market that matches households that wish, given their incomes, to boost the sum total of wealth that they have saved with businesses that, given the level of interest rates, seek to expand their productive capacity. At first glance it seems that there are three variables: spending, income, and interest rates. But recognize that everybody’s spending is somebody else’s income and see that there are really only two different variables here, and that the economy will settle at that level of interest rates, spending, and income where supply equals demand in the market for liquidity and also supply equals demand in the market for savings. We now have a framework: if we want the government to do something to boost jobs—boost people’s pre-tax and –transfer incomes—we need the government to do something to change the balance of supply-and-demand in either the market for liquidity or the market for savings, and we also need to make sure that whatever spending, income, and job-stimulating effect we create in the market in which the government intervenes is not undone by changes in the other market. In general (and with exceptions) things that the central bank—the Federal Reserve—does tweak supply-

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and-demand in the market for liquidity and things that the president and congress do tweak supply-and-demand in the market for savings. Right now, if you ask the decisive members of congress—the Blue Dog Democrats in the House, or the most conservative Democrats and most liberal Republicans in the Senate—why the president and the congress are not doing more to reduce unemployment and boost spending and income right now, the answer you will get is... well, you probably won’t get an intelligible answer, but if you did get an intelligible response it would go something like this: Additional policies to move supply-and-demand in the market for savings to boost spending would (a) increase the burden of the national debt on future tax payers and (b) lead to a large fall in bond prices and boost in interest rates as businesses tried to increase their liquidity to support higher spending, and that increase in interest rates would cause businesses to cut back on their investment, and so neutralize most if not all of the effect of more stimulative policies. Right now, if you ask the Federal Reserve why it isn’t doing more to reduce unemployment and boost spending and income, the answer you will get is: we have done all that we can do, spending is not at all constrained by a shortage of liquidity because we have flooded the zone, and additional efforts on our part to tweak supply-and-demand in the market for liquidity threaten to fuel destructive inflation in the future without boosting employment and spending now. Both of these arguments are comprehensible: either might well be true. But the problem is that they cannot both be true at the same time. Either the economy is so awash in liquidity that the Federal Reserve cannot do much to boost spending—in which case additional spending by the government won’t generate any substantial rise in interest rates. Or additional government spending will crowd-out investment as interest rates rise as businesses scramble for liquidity—in which case the economy is not awash in liquidity, and quantitative easing by the Federal Reserve could do a lot right now to boost spending and employment.

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My view is that the right summit to have right now is a come-to-Jesus meeting between Obama’s National Economic Council plus the key “centrists” of the congress on the one hand and the Federal Reserve Open Market Committee on the other. The two groups seem to have very different and inconsistent views of the current situation. And if they could only reach agreement on who is likely to be right then the plan for rescuing the economy would become obvious. After all, nobody thinks that an economy in which the unemployment rate stays near 10% for the next year and a half or so is a healthy economy in a good state, do they? But that joint FOMC-NEC-congressional “centrists” summit is not the jobs summit we are going to have this week. December 1, 2009: 1097 words