A good first step, but full recovery would still be far, far away

The leaked document that purports to show the Obama administration’s opening bid for resolving the “fiscal cliff” is deeply encouraging, on many fronts—as detailed by Andrew Fieldhouse. Given how strong a proposal it is, and how in-line it is with many of the principles for fiscal policy that we have laid out in the medium– and long-run, it seems churlish to raise any note of criticism. It needs to be said, however, that as good as this proposal is, it still does not look like strong-enough medicine to solve the most pressing problem of sluggish economic growth and chronic joblessness in the coming years.

To be sure, if adopted it would turn fiscal policy from dangerously contractionary to supportive of growth in the next couple of years. And the most basic contours of their proposal, as Andrew notes, are actually very much in line with the proposed strategy we recently outlined.

FULL ANALYSIS FROM EPI: Budget battles in the lame duck and beyond

But, as our own paper noted, both our strategy and the Obama administration’s proposal start with the presumption that measures that are strong enough to reliably solve the crisis of joblessness in the near term are totally outside the bounds of political realism. 

However, this political judgment doesn’t change the underlying economics; simply put, there is no particular reason to believe that a full economic recovery will happen in the next few years unless fiscal policy pumps enough demand into the economy to make it happen. To be clear, a recovery without huge fiscal support is a theoretical possibility—a wave of consumer or business euphoria, or some staggering shift in international trade flows could generate enough demand to get the economy back to potential without expanded fiscal support. But there is zero reason to bet on this kind of recovery absent larger-scale fiscal support.

A guaranteed return to full recovery would require extra fiscal support on the order of five to six times as large as what the administration is proposing—and even the administration’s proposals are going to be awfully tough (probably impossible) to get through Congress intact. So, prospects for doing what is actually necessary to return to full recovery look awfully dim.

It’s important to note that there is essentially no downside risk to undertaking the amount of extra fiscal support that is needed to return to full-employment in the next couple of years. In all likelihood, the extra support will generate enough new growth to actually reduce the debt/GDP ratio, the most relevant metric of fiscal sustainability. And say the economy actually snaps back to full-employment quickly enough that there actually is some upward pressure on interest rates that crowd-out some private investment, would this be disastrous? Not if lots of the extra fiscal support came in the form of expanded public investment. Studies have shown that the rates of return to public investment are probably higher for the U.S. today than private, so a policy that has a low risk of substituting higher-return public investment for some private investment for a year or two hardly seems like a disaster in the making.

So, as good as the Obama administration’s opening bid is given the political context, it still reflects the depressing reality that the U.S. political system continues to be unable to attack the problem of joblessness with the urgency it merits. But I guess no long journey begins without an opening step, and this is a very good opening step.