The Next Recession: Keynote address

On April 18, 2019, Christina Romer gave the keynote address for a symposium on “The Next Recession”—exploring the potential causes and consequences of the next recession and discussing recommended policy responses. A transcript of Dr. Romer’s speech appears below.

Thank you so much. It is just such an honor and a pleasure to be here. I think this is an amazing event, and I so thoroughly enjoyed the first panel. Certainly as a speaker, an incoming speaker, I’m sitting here, I’m not sure what was more intimidating, the many things that they said that I was planning to say or the few places where I disagreed with them. So we’ll see how that goes.

I thought I’d start by sharing with you one of my most precious possessions, and it’s a Christmas ornament that I’m pretty sure is unlike any other in the world. It’s this one. It’s a counted cross-stitch ornament that my daughter made for me the first Christmas we were back from D.C. It is a representation of that ubiquitous sign that you saw at any of the Recovery Act Infrastructure programs. This one says, “This ornament funded by the American Recovery and Reinvestment Act,” right down to that black and orange tiger grant symbol.

And every holiday season when we take this out, it makes me remember a time when the government took bold action to help stem the worst economic crisis since the Great Depression. And so, in my talk today, I want to reflect on, one, what made the Recovery Act possible and some of the obstacles that policymakers had to overcome back in 2009, but then I want, in the spirit of the conference, to turn to the prospects for fiscal policy in the next recession: why it will be even harder the next time around, and, especially, sort of—part of the focus of that previous session—of what could we do today that might make fiscal policy a more viable tool for economic stabilization the next time we need it.

So let me start by taking you back to 2008 and 2009 and ask that question of what made it possible to use fiscal policy so aggressively at that particular moment in time? And I’m going to say here, first, never underestimate the power of fear, because the world economy really was imploding right before our eyes. And I will never forget the first Friday of December in 2008, because I had been in D.C. as the designate for CEA chair for all of a week when the employment report for November 2008 was released. And if you remember it, it was awful, right? We not only learned that we’d lost half a million jobs in November, but we also learned that we’d underestimated how many jobs we’d lost in September and October of that horrible fall. And so that was another 200,000 job losses in revisions. And so, all told, that morning we learned that employment was three-quarters of a million jobs lower than we might’ve thought just the night before.

And I remember it vividly because I was pulled out of a meeting. The president-elect was still in Chicago, but I was pulled out of a meeting because he wanted to be briefed on the numbers by phone. And when I got on, I was just practically incoherent. I just kept saying, “Oh my God. This is so awful. I’m so sorry. Oh my goodness, it’s a catastrophe.” I just kept going and he let me keep going. It felt like forever. And finally, he stopped me and he said, “Christie, it’s not your fault,” but—wait for it—“yet.”

And so that really drove home to me the magnitude, not only of what the country was facing, but what I was facing. And I think that sense of crisis and urgency certainly led the president to support a fiscal stimulus of unprecedented size and at least helped keep Democrats in Congress united. And I think it did win us the crucial “yes” votes of those three Republican senators that Heather mentioned, especially the two brave women senators from Maine. I think something else that helped us was a broad professional consensus in favor of bold fiscal action. So really as a way of getting outside views and of making the case within the transition team for aggressive fiscal stimulus, Larry Summers and I undertook a sort of a reaching out. We started just calling all of the economists we could find, kind of across the ideological spectrum, to get their opinions on what we should do.

And though the right-leaning economists tended to favor tax cuts over spending increases, what was really striking is that with just one exception, everybody was in favor of a substantial fiscal expansion at that point in time. And I think this professional consensus carried over somewhat, at least, to the political realm. And there was a mention … I think it was Josh who mentioned that Congress, under President Bush, had signed a substantial tax rebate early in 2008, called The Economic Stimulus Act of 2008. And it really drives home the idea that, at that point, stimulus was still a selling point, not an epithet. And so I think that that’s an important thing to realize.

I think, finally—and this is going to be a theme that comes up in some of what I say, and where you might see a little disagreement with some of what’s been said—I’m not sure we realized it at the time, but I think the fact that the U.S. debt-to-GDP ratio was relatively low did give us room to maneuver. So this is just the Congressional Budget Office’s numbers for the federal debt held by the public as a share of GDP. And certainly, thanks to the Clinton-era budget surplus, the housing boom’s effect on revenues, we did enter the Great Recession with plenty of fiscal space. Our debt-to-GDP ratio was under 40 percent, close to its postwar low, and it really was the case that policymakers never had to seriously question whether the U.S. had the borrowing capacity to undertake a bold fiscal response to the crisis.

All right. Now, while these conditions made it possible to pass the Recovery Act, one of the things we learned was that using fiscal stimulus was still far from easy. I think because monetary policy had been the key anti-recessionary tool for the previous 20 years, we had little knowledge of exactly how well a fiscal stimulus would work, and especially, which types of stimulus would be the most effective. So, for example, aid to state and local governments, so they didn’t lay off teachers and first responders, was something that really hadn’t been used as a countercyclical tool before. We also, unfortunately, learned that ramping up infrastructure spending really is hard, right? In the modern era, even supposedly shovel-ready projects are subject to bureaucratic legal and logistical delays.

And finally, I think I’ll be the first to admit that we managed expectations, both around the economy and around the Recovery Act, poorly. I think neither the economics team nor the communications folks spent enough time explaining to the American people just how severe a crisis we were facing and how large the risks were. And even though our estimates of the actual impact of the Recovery Act turned out to be spot on, our forecast of where the economy was headed without stimulus caused us no end of headaches. Right? That it allowed people to say that the Recovery Act was ineffectual, when, in fact, it was merely too small relative to the unexpectedly large worldwide collapse that we were facing.

All right. Well, that’s the past. Let’s turn now to thinking about the future and about the next recession. And I think, as so many people have already said this morning, no one knows when the next recession will come or what will cause it. But I do think it’s important to point out that economic fluctuations don’t follow a regular pattern and expansions don’t simply die of old age. Something has to knock us away from full employment. It might be the bursting of some new asset bubble, a trade war, a decline in consumer business confidence. And right now, though, there are tensions in all those areas. The U.S. economy appears to be relatively stable, so unemployment is blessedly low. And even some workers that we had thought had left the labor force forever, in the wake of the Great Recession, seem to be reentering as one of the benefits of a fairly high-pressure economy.

But importantly, another recession will surely come at some point. And again, as I think has been mentioned, we are going to enter that next recession in a difficult position. So this shows you the well-known graph of what’s happened to the federal funds rate, the main interest rate that the Fed controls. And as you can see, even with the few rate increases that we’ve had, interest rates are still at basically the lowest level they’ve been in 60 years. And importantly, they’re going to stay there, I think, for the foreseeable future. And we could talk about why, but it certainly seems as though that equilibrium, real interest rate, the real interest rate that keeps … that you need to have to keep at full employment, is just really low. And it may, for example, be part of a reflection of some of the things that Heather was saying, about higher inequality means that a lot of the income is going to people that don’t spend much of it. So how do you get enough demand? It means the equilibrium real rate has to be very low.

But I think what it … The big picture is what it means is the Fed will have limited ammunition the next time we fight a downturn, and for that reason alone, fiscal policy will be more important than ever.

Now, compared to 2008, however, we will have one big advantage in using fiscal policy, which is we have a lot better understanding. So one consequence of the use of fiscal stimulus, not just in the U.S., but around the world, has been just a blossoming of research on its impacts. And almost without exception, these new studies find that stimulus is very effective. So, for example, just at a broad level, countries that took more aggressive fiscal actions following the 2008 crisis—so, like China, Australia, and yes, the United States—had less severe post-crisis recessions than those that did less, like France and Italy and the U.K. And actually, one of the most persuasive studies looks specifically at that state and local fiscal relief component of the Recovery Act that was about a hundred billion dollars of the original fiscal stimulus. And that was a part of the Recovery Act where we had probably the least information or least certainty about what its impact would be.

And an interesting point is that, for practical reasons, much of that relief to state governments was just tied to the historical generosity of its Medicaid program, because it turned out that the easiest and fastest way to transfer money from the federal government to the states was just to increase that federal Medicaid matching percentage.

And as a result, there was variation in how much of the state fiscal relief states got that wasn’t tied to current economic conditions in the state. So what you can just see from this picture is that areas like D.C., New York, Vermont got more of this state fiscal relief for relatively exogenous reasons than other states, like Colorado, Nevada, and Utah. And what that variation, that relatively exogenous variation, let economists do is to see, “Well, did states that got more of this state fiscal relief for reasons unrelated to current conditions in the state, did they do better?” And the answer is: absolutely.

So this is just … If you’re into reading scatter plots, along the horizontal, we’re going to have that relatively exogenous amount of state fiscal relief that various states got. And along the vertical, we have what happened to the change in employment in that state in the first sort of six months of 2009. And what you’re supposed to see is a positive relationship. What it means is that states that got more of this state fiscal relief did better, or probably the right way to say it is—they did less bad. Right? So that they had smaller employment losses than states that got less of this state fiscal relief. The other thing that was amazing about this study is their estimated cost per job saved or created was really low, on the order of about $26,000 per job year. And so I think one of the things we learned from this study is that aid to states is likely to be one of the most straightforward and effective forms of anti-recession fiscal policy.

All right. Well, while we have the benefit of better understanding of fiscal stimulus the next time around, we are going to face two huge disadvantages. One, as again has been so mentioned before, is just the evaporation of the political consensus in favor of stimulus. And what’s so ironic is that this blossoming of new research has, if anything, helped to make the professional consensus in favor of fiscal policy even stronger than it was in 2008. And this is actually … I don’t know if you’re familiar, but the IGM forum at the University of Chicago does periodic surveys of its economic expert panels. And the experts are all distinguished economists, but importantly, they lean left, right, center.

And one of the questions that they asked was whether they agreed that the Recovery Act helped to lower the unemployment rate. And what you’re supposed to notice is 97 percent of the experts agreed or strongly agreed that stimulus was useful. And actually, they’d asked a similar question back in 2012, and what was really striking is the number of people that strongly agreed is even bigger now. I think that is the idea that we have better evidence than ever before that fiscal policy is a very effective tool for dealing with a recession.

Now unfortunately, any trace of political consensus in favor of fiscal stimulus in a recession has evaporated. And one of the things I found so striking is that even actions like extending unemployment insurance during a long downturn, which used to command just strong bipartisan support, are now highly controversial. I think it’s just truly frightening how divided the two parties have become on this fundamental issue.

A second disadvantage that I think we’re going to face is an evaporation of our fiscal space. And here’s where you’re going to see perhaps a little daylight between me and the earlier panelists. All right. So fiscal space just refers to really the room that policymakers have to take fiscal action, and it can be pretty well proxied by a country’s ratio of their debt to GDP. And part of the reason I feel so passionate about that these days is I’ve been doing a lot of research with my colleague and husband, David Romer, where we look at how a country’s fiscal response to a financial crisis varies with their debt-to-GDP ratio.

So we’re going to look at a broad sample of relatively advanced economies, going back to 1980, and we’re going to estimate how the response of their high employment budget surplus, that measure of sort of deliberate fiscal policy, after a crisis varied with their debt-to-GDP ratio. All right. And this figure is going to show you the results. So the blue line shows what countries with fairly low fiscal space, with a high debt-to-GDP ratio, did to their high employment surplus. And the red line shows what countries with a low debt-to-GDP ratio typically do after a financial crisis. And what you’re supposed to see is the countries with a lot of fiscal space, that red line, do exactly what you’d want them to do. They cut their high employment surplus, they deliberately move their budgets into deficits.

But what you see is that countries that started a financial crisis with a high debt-to-GDP ratio take their budget surplus in exactly the wrong direction. Right? That rather than running expansionary fiscal policy, they actually end up running contractionary fiscal policy. And the numbers are huge. This is increasing their budget surplus by as much as 4 percent of GDP.

And actually, one of the new papers that we just did is actually looking at why countries behave that way. And we find it’s a mixture of sometimes countries with a high debt-to-GDP ratio really do run into trouble for markets, really do find they can’t borrow, or have to pay a very high interest rate. But we also do see a big role for policymakers’ ideas, that it seems like policymakers get it into their heads that if they have a high debt ratio, they can’t do anything. The reason I point this out is if you look at what’s happened to our fiscal space, to our debt-to-GDP ratio, over the last 10 years, it is quite surprising, I think, quite worrisome. So we certainly see the actual budget deficit, as measured by the CBO, has gone up a lot, and then their projections are even more horrible going forward.

And so I think one of the things that means is we are likely to hit the next recession with a lot less fiscal space than we had back in 2008. And actually, I think this feeds in again to something that Heather said earlier. I think it really points out a way in which the Trump tax cuts are even more destructive than we might have realized. So, of course, they had terrible effects on inequality, on who we were redistributing income to, but another effect is that they’ve set in train long-term structural deficits that are eating up the fiscal space that we could actually use and would need to use the next time that we faced a recession.

All right. So that brings me to the last big topic, which is—I’ve suggested there are going to be problems in using our fiscal policy in the next recession. Are there actions we could take today that would make it more likely that we would be able to use fiscal policy in the future? And here, I have a few suggestions. The first is to do exactly what EPI is doing today, which is to try to educate the public. I think that think tanks, congressional committees, thought leaders, have to be highlighting the new research on the effectiveness of fiscal policy. And here, I’ll make a plea to spotlight the young researchers, who are actually doing the work, publishing it in top economics journals, because I think we need to kind of take the partisan battles of the past out of the discussion and focus on the new empirical research.

The other thing we’re going to need to do is to be honest about describing the findings. So most of them are strongly of the view that fiscal stimulus works, but not all of them go in exactly the same direction. For example, it appears that tax cuts that show up just in lower withholding, as we had in the Recovery Act or as we saw in the Trump tax cuts, don’t seem to pack as big an expansionary punch as writing people a highly publicized tax rebate check.

I think a second thing that we should do is to rein in our budget deficit in good times to make fiscal space for bad times. And here, let me just be clear that I agree with so much of what the panel before said. There is a tremendous amount of good spending that we should be doing right now. We need to be investing in infrastructure. We need to be taking massive actions to combat climate change. We should be expanding access to health care and education so every American has an equal opportunity to thrive, both physically and economically. But I think we shouldn’t give in to the view that budget deficits don’t matter, because I think that they do. And one important way that they do is in limiting the fiscal response to a recession. So I’d basically put in a plug that in times of full employment, we should pay for the good things that we want to do with higher taxes and cuts in unnecessary spending. And here, I couldn’t agree with Angela more.

We can afford to do the things that we need to do, but we ought to pay for them, right? We ought to be using taxes and cuts in unnecessary spending to do the good things that would make the economy stronger. All right. And I think that it will have the benefit, besides accomplishing good things, of getting our debt-to-GDP ratio moving in the right direction, which is it needs to go down, rather than up as dramatically as it has been, so that policymakers won’t hesitate to do fiscal stimulus when they need to.

And finally, again, I think just such a crucial point from the earlier panel is we need to plan right now for the fiscal policy that we would use in the next recession. Again, thinking back to December of 2008 when the world is falling apart, that is a hard time to be trying to design the perfect fiscal stimulus. We should be thinking about that right now. And so, for example, building on that study that I mentioned, that state fiscal relief is a really valuable tool, we should be thinking right now about how we could do it more equitably, more quickly, so that we get it to the states that are most severely affected if we face another recession.

Another place where I really agreed with the panel a lot: I think devising an effective public employment program for hard times would be another great thing to do. This was something that President Obama would have liked to do in 2009, and we just couldn’t figure out a way to do widespread public employment quickly and cost-effectively. In fact, I had the surreal experience of … I just started calling cabinet secretaries in 2009, and I said, “How many people could your agency or department usefully employ if funds were available?” And a typical answer was, “Oh, tons. Maybe 15, even 20,000.” And I’m sitting here going, “We have 15 million people unemployed. A couple hundred thousand public jobs is just not going to do much.” But I think widespread public employment should be possible.

And here, we’ve already had several references to the Great Depression and the New Deal. I just wanted to actually give you some numbers that will really drive that home. Franklin Roosevelt, in the winter of 1934, managed to put four million people to work through the Civil Works Program. That was eight months after he had taken office. The WPA routinely employed close to three million people in several of those years in the mid-1930s. And of course, my favorite, the Civilian Conservation Corps put hundreds of young men to work improving our national parks and doing other conservation projects.

And actually, one of the few truly joyous times of my time in Washington was when, quite early on in my tenure, a group of now very old men, who had worked on CCC projects, came to see me at the CEA. And their description, not only of what the public employment had meant for their families … One probably not well-known fact is we sent these young men off to the woods to do this work, and then they sent three-quarters of their paychecks home to their mothers. And so it not only helped them, it helped their families … But these men, who are now all in their eighties and nineties, were describing how this job, in this terrible time, not only had saved their families, but transformed their lives and made them more productive citizens in the future.

And so what I really think we should be doing, I think, with enough creativity and planning, we could surely come up with a program that could put large numbers of people to work doing useful activities in the next serious recession. And we heard some great ideas, right? Getting the lead out of the houses in Cleveland. So I’d put public school repair, environmental cleanup … As an economic historian, I’d love to see all of our government documents digitized. Teacher’s aides in classrooms. There are ways we could put lots of people to work, but I think only if we have the programs in our back pocket, ready to go, when the time comes. And I think, coming back or moving a little bit into the political realm, I think a fiscal policy that puts people directly to work doing useful things is going to be a lot more palatable, to both politicians and voters, than the more amorphous fiscal stimulus.

And then finally, I think as Heather mentioned, better and stronger automatic stabilizers would be really valuable. Right? So a more progressive tax system naturally means that tax revenues go up more in a boom and down more in a recession, and that’s great for stabilizing output. But again, we should think more creatively. Could we make extensions or expansions of unemployment compensation in long or severe recessions automatic? Could we make state fiscal relief automatic as well, if the unemployment rate in a state hits a certain level? I think those kinds of things that we could be thinking about now would be excellent additions to our anti-recession arsenal, because I think taking politics out of the use of countercyclical fiscal policy is the best way to make sure that we’d have the right policy response at the right time.

Now, what surely is the case is that all of the moves that I’ve described would help make fiscal policy a more viable tool in the next recession, but I don’t have to tell you that any of them are going to be an incredibly heavy lift in the current political environment. But I guess the reason I’m here, I think the reason we’re all here, is that we just can’t stop trying to nevertheless get them to be part of the discussion. Because facing another economic meltdown, with our most effective countercyclical tool, is not just going to be a heavy lift. It is truly unthinkable. So we’ve got to think about this now. So, thank you.

See more work by Christina Romer