Back to Business as Usual? Or a Fiscal Boost?

Levy Economics Institute, Strategic Analysis Series, Forthcoming

12 Pages Posted: 25 Apr 2012 Last revised: 25 May 2012

See all articles by Dimitri B. Papadimitriou

Dimitri B. Papadimitriou

Bard College - Levy Economics Institute

Greg Hannsgen

Bard College - Levy Economics Institute

Gennaro Zezza

University of Cassino - Department of Economics; Bard College - The Levy Economics Institute

Date Written: April 23, 2012

Abstract

Though the economy appears to be gradually gaining momentum, broad measures indicate that 14.5 percent of the U.S. labor force is unemployed or underemployed, not much below the 16.2 percent rate reached a full year ago. In this new report in our Strategic Analysis series, we first discuss several slow-moving factors that make it difficult to achieve a full and sustainable economic recovery: an ongoing tilt in income distribution toward the wealthiest 1 percent of households; a failure to fully stabilize and re-regulate finance; serious fiscal troubles for state and local governments; and detritus from the financial crisis that remains on household and corporate balance sheets. These factors contribute to a situation in which employment has not risen fast enough since the supposed end of the recession to significantly increase the employment-population ratio. Meanwhile, public investment at all levels of government has fallen from roughly 3.7 percent of GDP in 2008 to 3.2 percent in the fourth quarter, helping to explain the weak economic picture.

For this report, we use the Levy Institute macro model to simulate the economy under the following 3 scenarios: (1) a private borrowing scenario, in which we find the appropriate amount of private sector net borrowing/lending to achieve the path of employment growth projected under current policies by the Congressional Budget Office (CBO), in a report characterized by excessive optimism and a bias toward deficit reduction; (2) a more plausible scenario, in which we assume that the federal government extends certain key tax cuts and that household borrowing increases at a more reasonable rate than in the previous scenario; and (3) a fiscal stimulus scenario, in which we simulate the effects of a fully “paid-for” 1 percent increase in government investment.

The results show the importance of debt accumulation as a consideration in macro policymaking. The first scenario reproduces the CBO’s relatively optimistic employment projections, but our results indicate that this private-sector-led growth scenario quickly brings household and business debt to new all-time highs as percentages of GDP. We note that the CBO makes its projections using an orthodox model with several common, but fundamental, flaws. This makes possible the agency’s result that current policies will reduce the unemployment rate without a run-up in the private sector’s debt — “business as usual,” in the words of our report’s title.

The policies weighed in the second scenario do not perform much better, despite a looser fiscal stance. Finally, our third scenario illustrates that a small, tax-financed increase in government investment could lower the unemployment rate significantly — by about one-half of 1 percent. A stimulus package of this size might be within the realm of political possibility at this juncture. However, our results lead us to surmise that it would take a much more substantial fiscal stimulus to reduce unemployment to a level that most policymakers would regard as acceptable.

Suggested Citation

Papadimitriou, Dimitri B. and Hannsgen, Greg and Zezza, Gennaro, Back to Business as Usual? Or a Fiscal Boost? (April 23, 2012). Levy Economics Institute, Strategic Analysis Series, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2044815 or http://dx.doi.org/10.2139/ssrn.2044815

Dimitri B. Papadimitriou (Contact Author)

Bard College - Levy Economics Institute ( email )

Blithewood
Annandale-on-Hudson, NY 12504
United States
845-758 7711 (Phone)
845-758 9424 (Fax)

Greg Hannsgen

Bard College - Levy Economics Institute ( email )

Annandale-on-Hudson, NY 12504-5000
United States

Gennaro Zezza

University of Cassino - Department of Economics ( email )

Cassino
Italy

HOME PAGE: http://gennaro.zezza.it

Bard College - The Levy Economics Institute ( email )

Blithewood
Annandale-on-Hudson, NY 12504-5000
United States

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