A Boost That Goes Nowhere
By Joseph Stiglitz
Sunday, November 11, 2001; Page B01
The United Statesis in the midst of a recession that may well turn out
to be the worst in 20 years, and the Republican-backed stimulus
package will do little to improve the economy -- indeed it may make
matters worse. In the short term, unemployment will continue to rise
and output will fall. But the U.S. economy will eventually bounce
back -- perhaps in a year or two. More worrying is the threat a
prolonged U.S. recession poses to the rest of the world.
Already we see inklings of the downward spiral that was part of the
Great Depression of 1929: Recession in Japan and parts of East Asia
and bare growth in Europe are contributing to and aggravating the U.S.
Emerging countries stand to lose the most. Globalization has been sold
to people in the developing world as a promise of unbounded
prosperity -- or at least more prosperity than they have ever seen.
Now the developing world, especially Latin America, will see the
darker side of its links to the U.S. economy. It used to be said that
when America sneezed, Mexico caught a cold. Now, when America sneezes,
much of the world catches cold. And according to recent data, America
is not just sneezing, it has a bad case of the flu.
October unemployment figures show the largest monthly increase in two
decades. The gap between the United States's potential gross domestic
product -- what it would be if we had been able to maintain an
unemployment rate of around 4 percent -- and what is actually being
produced is enormous. By my calculations, it is upwards of $350
billion a year! This is an enormous waste of resources, a waste we can
It is widely held that every expansion has within it the seeds of its
own destruction -- and that the greater the excesses, the worse the
downturn. The Great Boom of the 1990s had marked excesses. Irrational
optimism has been followed by an almost equally irrational pessimism.
Consumer confidence is at its lowest level in more than seven years.
The low personal savings rate that marked the Great Boom may put even
more pressure on consumers to cut back consumption now.
It seemed to me that we were headed for a recession even before Sept.
11. In the coming months we will have the numbers that make clear that
we are squarely in one now. The economic cost of the attacks went well
beyond the direct loss of property, or even the disruption to the
airlines. Anxieties impede investment. The mood of the country
discourages the consumption binge that would have been required to
offset the reduction in investment.
In any case, monetary policy -- the Federal Reserve's lowering of
short-term interest rates to heat up the economy -- has been vastly
oversold. Monetary policy is far more effective in reining in the
economythan in stimulating it in a downturn, a fact that is slowly
becoming apparent as the economy continues to sink despite a massive
number of rate cuts; Tuesday's was the 10th this year.
The Bush administration's tax cut, which was also oversold as a
stimulus, is likely to haunt the economy for years. Now the consensus
is that a new stimulus package is needed; the president has ordered
Congress to have one on his desk by the end of the month. Much of the
stimulus debate has focused on the size of the package, but that is
largely beside the point. A lot of money was spent on the Bush tax
cut. But the $300 and $600 checks sent to millions of Americans were
put largely into savings accounts.
What worries me now is that the new proposals -- particularly the one
passed by the Republican-controlled House -- are also likely to be
ineffective. The House plan would rely heavily on tax cuts for
corporations and upper-income individuals. The bill would put zero --
yes, zero -- into the hands of the typical family of four with an
annual income of $50,000. Giving tax relief to corporations for past
investments may pad their balance sheets but will not lead to more
investment now when we need it. Bailouts for airlines didn't stop them
from laying off workers and adding to the country's unemployment
The Senate Republican bill, which the administration backs, in some
ways would make things even worse by granting bigger benefits to very
high earners. For instance, the $50,000 family would still get zero,
but this plan would give $500,000 over four years to families making
$5 million a year -- and much of that after (one hopes) the economy
has recovered. It directs very little money to those who would spend
it and offers few incentives for investment now.
It would not be difficult to construct a program with a much bigger
bang for the buck:
. America's unemployment insurance system is among the worst in the
advanced industrial countries; give money to people who have lost
their jobs in this recession, and it would be quickly spent.
. Temporary investment tax credits also would help the economy. They
are like a sale -- they induce firms to invest now, when the economy
. In every downturn, states and localities have to cut back
expenditures as their tax revenues fall, and these cutbacks exacerbate
the downturn. A revenue-sharing program with the states could be put
into place quickly and would prevent these cutbacks, thus preserving
vitally needed public services. Many high-return public investments
could be put into place quickly -- such as renovating our dilapidated
This may all sound like partisan (Democratic) economics, but it's not.
It's just elementary economics. If you really don't think the economy
needs a stimulus, either because you think the economy is not going
into a tailspin or because you think monetary policy will do the
trick, only then would you risk a minimal-stimulus package of the kind
the Republicans have crafted in both the House and Senate.
But what matters is not just how I or other economists see this: It
matters how markets, both here and abroad, see things. The fact that
medium- and long-term bond rates (that is, bonds that reach maturity
in five or 10 years or more) have not come down in tandem with
short-term rates is not a good sign. Nor is the possibility that the
interest rates some firms pay for borrowing for plant and equipment
may actually have increased.
In 1993, a plan of tax increases and expenditure cuts that were phased
in over time, providing reassurances to the market that future
deficits would be lower, led to lower long-term interest rates. It
should come as no surprise, then, that the Bush package, with its tax
decreases and expenditure increases, would do exactly the opposite.
The Federal Reserve controls the short-term interest rates -- not the
medium- and long-term ones that firms pay when they borrow money to
invest, or that consumers pay when they borrow to buy a house, which
are still far higher than the short-term rate, which now stands at its
lowest level in 40 years. Whatever monetary policy does in lowering
short-term rates can be largely undone by an administration's
misguided fiscal policy, which can increase that gap between short and
long rates; that gap has widened considerably.
Worse still, America has become dependent on borrowing from abroad to
finance our huge trade deficits; and the reduction in the surplus is
likely to exacerbate this (on average, the two move together). If
foreigners become even less confident in America, they will shift
their portfolio balance, putting more of the money elsewhere. That
adjustment process itself could put strain on the U.S. economy. Before
the terrorist attacks, confidence abroad in America and the American
economy had eroded, with the bursting of the stock and dot-com
bubbles. The two remaining pillars of strength were the quality of our
economic management and our seeming safety. Both of these have now
been questioned -- and the stimulus package likely to become law has
nothing to allay foreigners' fears.
As a former White House and then World Bank official, I have had the
good (or bad) fortune to watch downturns and recessions around the
world. Two features are worth noting.
First, standard economic models perform particularly badly at such
times; they almost always underestimate the magnitude of the downturn.
One relies on these models only at one's peril. The International
Monetary Fund and the U.S. Treasury badly underestimated the magnitude
of the Asian downturns of 1997 -- and this mistake was at least partly
responsible for the disastrous IMF policies prescribed in Indonesia,
Thailand and elsewhere.
Second, there are long lags and irreversibilities: Once it is clear
that the downturn is deep, and a stronger dose of medicine is
administered, it takes six months to a year for the effects to be
fully felt. Meanwhile, the consequences can be severe. The bankrupt
firms do not become unbankrupt and start functioning again.
Downturns are likely to be particularly severe when the economy is hit
by a series of adverse shocks. Market economies such as ours are
remarkably robust. They can withstand a shock or two. But even before
terrorism came ashore, America had been hit badly.The attacks added
political uncertainty to the already great economic uncertainty.
So here we are, facing a major downward spiral. This is where eroding
confidence in economic management comes into play. John Maynard
Keynes, the founder of modern macroeconomics, (including the notion of
the stimulus) emphasized the importance and vagaries of investors'
"animal spirits" -- that is, the unpredictability of their optimism
and pessimism. But expectations, rational or irrational, about the
future are of no less importance to consumers. Those who are worried
about losing their jobs are more likely to cut back on their spending
and to save the proceeds from any tax cuts.
It was great fun being part of the Great Expansion. Every week brought
new records -- the lowest unemployment rate in a quarter-century, the
lowest inflation rate in two decades, the lowest misery index in
three. The good news fed on itself, and the confidence helped fuel the
expansion. We took credit where we could, but I knew that much of this
was good luck -- and the Clinton administration and Fed not messing
Now, every week brings new records in the other direction -- the
largest increase in unemployment and decline in manufacturing in two
decades, the first quarterly fall in consumer prices in nearly a
half-century, the slowest growth in nominal GDP in any two consecutive
years since the 1930s. Americans love records, but unfortunately,
these new ones are contributing to the already pervasive sense of
anxiety. The Bush administration will not try to claim credit for
these new records; rather, it will blame Sept. 11. Osama bin Laden is
a convenient excuse, but the data will show his murderous henchmen
were aiding and abetting at best: The economy was already sliding
I wish I could be more optimistic about our economy's prospect. I
worry that all of this naysaying will simply contribute to the
downturn. Perhaps I am wrong, and the economy will, on its own,
But perhaps I am right. Then, without an effective stimulus, the U.S.
economy will sink deeper into recession, and the rest of the world
with it. An ineffective stimulus could be even worse: It would harm
budgetary prospects, raising medium- and long-term interest rates. And
when we see the false claims for what they are, confidence in our
economy and in our economic management will deteriorate further. We
have had a first dose of this particular medicine. We hardly need
Joseph Stiglitz was awarded the Nobel Prize in Economics last month. A
professor at Columbia University, he was chairman of the Council of
Economic Advisers from 1995 to 1997 and chief economist of the World
Bank from 1997 to 2000.