The Steer America Needs

The Federal Reserve had to admit yesterday what was now becoming clear to all observers of the American economy: The recovery has slowed and the data coming from the markets are worrying. In short, it’s serious.

On one hand, you can’t really say that the economic policy is not doing anything: The Fed’s monetary policy is highly expansive and therefore the U.S. economy is swimming in liquidity. The huge fiscal stimulus launched last year will still cost hundreds of billions of dollars this year. Nevertheless, there’s no sign of inflationary pushes, and the economy remains anemic, in a stalemate, with an unemployment rate that doesn’t seem to be slowing down. If we observe the labor market more closely, the situation doesn’t improve at all: Not only is unemployment stable, but we notice a significant increase in long-term unemployment, a dramatic burden especially for middle class families. Unemployment is long term, typically, when the labor market goes through a phase of adjustment and restructuring: The areas of potential growth can’t find skilled labor, while other sectors significantly reduce the labor demand.

For example, the market requires nurses but is left with an excess of masons and carpenters. Several indicators of labor demand by sector (e.g., the ratio between the number of job advertisements placed by enterprises and the unemployment rate) seem to confirm this hypothesis: The U.S. economy is in the midst of a difficult industrial restructuring that slows it down.

But that’s not all. The sluggish recovery also derives from the failure of fiscal policy, the stimulating effects of which seem to have lost power. In part, this failure is due to an inefficient distribution of expenditure. For example, interventions in infrastructure spending have not yet contributed significantly to the recovery because they tend to have delayed effects, despite the assurances of the administration, which stated that they have chosen projects that are shovel-ready. Above all, a fiscal policy is likely to have greatly reduced effects when families and businesses fear a short-term increase in the tax burden.

Unfortunately, this is exactly the case in the United States. Everybody is expecting an increase in taxes after the election to renew the Congress and Senate next November. The increase in the tax burden is almost inevitable given the public budget situation, which is affected by military spending for the two wars of the Bush era and by the explosive spending projections for health care and pensions over the next decade. Although the Obama administration has largely inherited this budget situation, it’s guilty of not having understood the gravity of the situation so far. The administration has underestimated the budget problems so much that, for months, it has pushed Congress to “exploit the crisis” to establish a welfare system the country needs in the medium term but that is more likely to induce crisis right now, when the country can’t take it. This is a huge error that led Congress not to approve new long-term unemployment benefits the labor market desperately needs.

If, as I believe, the reasons for the sluggish recovery are partly structural and partly due to expectations of an imminent fiscal tightening, it leaves little space for maneuvering the monetary policy.

Yesterday’s announcement about the rates was due and largely expected. Certainly the Fed will return to the policy of “quantitative easing” that has had remarkable success in the early stages of the crisis: It will acquire medium-term securities in order to lower the entire rate structure, not just the short-term ones in its direct control. It will also try to generate expansive expectations by suggesting that it will not raise rates when faced with inflation. But all this will only have secondary effects now.

Even a new fiscal stimulus, of which there’s insistent talk, will have little effects unless the budget problems are solved, especially the serious ones relating to public health spending for the elderly (Medicare). Unfortunately, it is inconceivable that this will happen before the election, which is going to be hard for the Democratic Party. In several cases, from Reagan to Clinton, the results of the election for the renewal of Congress led the president to a significant policy shift. We look forward to it.