Pethokoukis

Obama didn’t end the Great Recession that Bush didn’t cause

Reuters

Reuters

If you think George W. Bush’s economic policies caused the Great Recession and Barack Obama’s ended it, then your Election Day decision is likely an easy one. But placing politics aside, I don’t think the economic evidence supports that thesis. I’ve stated my reasons, in bits and pieces, across several blog posts. Maybe now would be a good time for a unified, though brief, rebuttal.

Let’s take the two strands of the argument and examine each. First, did Bushonomics cause the worst economic downturn and financial crisis since the Great Depression? To make that case, you need to specify a policy causality (or two or three) and a transmission channel. But when you go down the list of usual suspects, none of them pans out:

– It was the Bush tax cuts. Except lowering taxes increases demand and improves supply-side incentives. The only way this theory might be true is if bond markets feared tax cuts would be inflationary or would hurt the ability of the US to pay back its debts. But interest stayed low during the 2000s. Also note that Obama says he wants to again extend most of these cuts.

– It was Bush’s income inequality. Except that a 2012 study, Does Inequality Lead to a Financial Crisis by economists Michael Bordo and Christopher Meissner, seems to dismiss that linkage. Using data from a panel of 14 countries for over 120 years, they found “strong evidence linking credit booms to banking crises, but no evidence that rising income concentration was a significant determinant of credit booms. Narrative evidence on the US experience in the 1920s, and that of other countries in more recent decades, casts further doubt on the role of rising inequality.”

– It was the Bush budget deficits. Except both inflation and interest rates were low during the 2000s. This is really another version of the tax cut argument, but adds in deficits from Medicare expansion and the wars in Iraq and Afghanistan. Besides, annual budget deficits averaged just $220 billion from 2001-2007. During the 2010-2012 recovery, they’ve averaged roughly $1.3 trillion. So deficits caused the Great Recession even though they are six times higher now?

– It was Bush’s financial deregulation. Except the law that ended Glass-Steagall was signed by President Bill Clinton. And few analysts think the end of Glass-Steagall directly contributed to the financial crisis. Another candidate was a 2004 rule change by the Securities and Exchange Commission that supposedly allowed broker dealers to greatly increase their leverage, contributing to the financial crisis. But as Prof. Andrew Lo of MIT explains in a 2011 paper, ”… it turns out that the 2004 SEC amendment to Rule 15c3–1 did nothing to change the leverage restrictions of these financial institutions.”

So what did cause the Great Recession? Politicians love to blame big downturns on “market failures.” Doing so then allows them to expand government and their own power. That’s what happened during the Great Depression. But it wasn’t the free market that failed back then, it was the Federal Reserve.

And the same goes for the Great Recession. In The Great Recession: Market Failure or Policy Failure, Robert Hetzel, a senior economist at the Richmond Fed, pins the blame squarely on the US central bank. The downturn first started with “correction of an excess in the housing stock and a sharp increase in energy prices” — the housing bust and the oil shock. Those two things were enough, in Hetzel’s view, to cause a “moderate recession” beginning in December 2007.

But it was the Fed’s monetary policy miscues after the downturn began that turned a run-of-the-mill recession into a once-in-a-century disaster. Not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members.

In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%. As Hetzel writes in a Fed paper that inspired the book, “Restrictive monetary policy rather than the deleveraging in financial markets that had begun in August 2007 offers a more direct explanation of the intensification of the recession that began in the summer of 2008. Irony abounds.’

And what ended the Great Recession? Was it the $800 billion Obama stimulus? As I have often pointed out, White House economists thought the stimulus would help lead to roughly 5% unemployment and 4% GDP growth in 2012.

Instead, the US economy is growing at half that pace and unemployment is sharply higher — even before you account for the massive drop in labor force participation.

But what do left-of-center or pro-Obama economists say? Here are Alan Blinder and Mark Zandi in a 2010 paper:

 In this paper, we use the Moody’s Analytics model of the U.S. economy—adjusted to accommodate some recent financial-market policies—to simulate the macroeconomic effects of the government’s total policy response. We find that its effects on real GDP, jobs, and inflation are huge, and probably averted what could have been called Great Depression 2.0.

For example, we estimate that, without the government’s response, GDP in 2010 would be about 11.5% lower, payroll employment would be less by some 8½ million jobs, and the nation would now be experiencing deflation.

When we divide these effects into two components—one attributable to the fiscal stimulus and the other attributable to financial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative easing—we estimate that the latter was substantially more powerful than the former.

So Blinder and Zandi credit the Fed and TARP, Bernanke and Bush, mostly for breaking the back of the downturn. Indeed, the steepest drops in GDP ended before Obama took office and before the stimulus kicked into gear. And eventually, of course, the economy would recover on its own as long as government didn’t interfere with anti-growth policies such as tax hikes or massive new regulations.

23 thoughts on “Obama didn’t end the Great Recession that Bush didn’t cause

  1. The author commits a number of logical fallacies in this propaganda piece. The chief among these is to assume that “lowering taxes increases demand and improves supply-side incentives.” This assumption does not hold. Net taxes among the very wealthy – those holding primarily interest-bearing instruments as wealth – are lower than middle class taxes. Combine that with decades of low wage growth relative to productivity, and higher net taxes paid by the middle class compared to the property-owning super-rich, along with huge losses in the chief investment of middle class people- their home; and the result is no increase in demand, and supply-side incentive is to continue to move production to low cost foreign markets, in turn helping to push up those unemployment numbers.
    Secondly, the author separates several Bush policies as if to show no single one caused the financial collapse. But the effects should be taken together.
    Besides, “Bush” v “Obama” is just marketing to voters, doesn’t really explain why the financial collapse happened. It’s propaganda. As the author rightly notes, Clinton was instrumental in repealing Glass-Steagall, but it is pretty far-fetched to say, “few analysts think the end of Glass-Steagall directly contributed to the financial crisis.” In fact, many analysts do. Nevertheless, this and whatever obscure rule that was brought up, are both just straw men, because it is the combined effects of years of multiple deregulations, and lack of regulation of new financial instruments, that in sum are the culprit – none of which are mentioned – including allowance of CDS and CDO, mortgage backed securities whose ratings differ from the ratings of their contents, and loose rules for mortgage lending. These are all ignored, and should be well-known.
    Still, ironically, the author blames the Fed, which is correct, it is part of the problem; but the author seems confused because he says the Fed was too restrictive with money in the crucial period in 2008 – even though the author, a free-market analyst, ought to be blaming the Fed for being so loose with money for years and years leading up to 2008, which led to that big unsustainable housing bubble.
    No, sir, the Fed’s tight policy in 2008 was part of it too. It was decades of loose money, pumping up a bubble, followed by a swift turn and then restrictive money policy. This was a last crucial step in a huge transfer of wealth away from the middle class (in the form of homes and wages) to the wealthy (in the form of stocks and bonds). And the fiscal stimuli – the loose money in that came later after the Fed wasn’t loose enough with money in 2008 – whether it was stimulus or bail-out, much of the money went to the corporations, not workers or consumers. Somehow, lately, Libertarians remain willing to see deep cuts to the government safety net for those people. Might be because they have no money with which to make their case.

    • Thank you for that reasoned response, Chris.
      Mr. Pethokoukis likes to cherry pick the data that suits his prejudices, and fiddles to the tune.

      As far as the repeal of the Net Cap rule, there IS some controversy on this, and I will hopefully get a chance to study the opposing view. However, people should note by this time, all of that leverage was being funneled straight into subprime paper- using leverage to buy leverage. It was the key reason behind the Bear and Lehman collapses:

      “We have a good deal of comfort about the capital cushions at these firms at the moment.” — Christopher Cox, chairman of the Securities and Exchange Commission, March 11, 2008.

      http://www.nytimes.com/2008/10/03/business/03sec.html?pagewanted=all

      • Still not getting the Bush/Republican angle on all this.
        Perhaps you or another here could flesh out the narrative a bit more. Bush policies as distinct from Clinton, say, or Gore or Kerrey for that matter. What Daschle and later Reid/Pelosi or Obama in the Senate did to stop Bush, etc.

    • The principal cause of the recession was the fallacy, widely held, that housing prices could not fall in national aggregate. That makes it Greenspan’s recession in my book, for his failure put away the punch bowl. I’d also quibble with the notion that the housing bust was a transfer of wealth from the middle class to the wealthy. Home equity flat disappeared, and remains gone for the near future. Demand, and the economy, will suck until home prices recover or savings reach some level of comfort. One hopes the supply-siders will wake up today and wonder if that Keynesian thing might not have value after all. Absent that, one hopes Obama grows a pair and takes his case to the people

      Now the Bush tax cuts, by severely limiting options to deal with Social Security, is in fact the largest upward transfer of wealth in our history, and represents an indelible stain on Bush’s legacy.

      • Bush cut income taxes. Social Security is financed by the payroll tax. Different animals. And Bush did propose Social Security reform – partial privatization – which was rejected and yet has been adopted in Sweden (of all places.)

        PS: Wealth (goods/services) is created. And it is owned by those whose efforts brought it into being. A basic concept, or human right, unless you support slavery.
        If your tax bill goes down, you are transferring less of your wealth to the government, not the other way around.

  2. A cou;le of questions for the liberal thinkers out there. Does this election now mean that Mr. Bernanke, Mr. Giethner, and Mr. Obama now own the economy? If not who is to blame for what happens? To me there comes a time when one has to take responsibility for one’s actions.

    • I think the use of the term “ownership” is loaded, and conveys someone just grabbing the steering wheel from someone else. It’s not that simple.

      We are engaged in a very long process. Looking back, many decisions that were made created streams of leverage, regulatory errors, and loose money.

      That process continues today, in many different ways: the deleveraging of personal households; the massive refinancing of corporate debt at give-away yields (E*Trade is pricing a new deal at around 4.5% and the balance sheet is blood red- just unreal), the fortification of bank balance sheets, digesting new regulations, and the changing nature of the kind of jobs that will be available to Americans.

      For all this time, AEI “fellows” have characterized the economy as a diorama where they can move pieces around to their liking to show a desired result. It’s much deeper than that: we are heading into a total remaking of the American economic landscape, there is no relying on the gauzy, nostalgic reminiscences of past recoveries, and again, this is a complex conversation that the American voter does not have the attention span, or intelligence, to digest.

      Ownership implies responsibilty. Who, ultimately, is responsible for history?

      • That is my point responsibility.. Are we not responsible for the decisions that we make. If we cannot take that responsilbility then we should not be in the position to make them. NOt everyone or every business is given the option to abdicate this and not go broke.. And I also have far greater faith in the American voter to be able to understand what is happening.

        • Of course Obama is responsible for his own policy, as far as getting us out of this rut. But again, this is a long term proposition, and people just don’t want to acknowledge it. Quite frankly, I will count the nation as lucky if we get job growth over 200k per month for a good stretch of time, and I am aware we need more than that.

          • The Depression was a ‘long term’ proposition as well.
            Just a coincidence, then, that we are pursuing the same toxic policy mix today: greatly increased government – spending, taxing, regulation. And 0% interest rates. A permanently larger government yields a permanently smaller economy – this is the new normal. Low to no growth, flat to falling incomes, high unemployment – we have become Europe.

          • I would commend to you that after Lehman blew up, Europe was doing a lot better than us in unemployment and their economies. Like us, their excesses are coming home to roost, but those excesses have nothing to do with what you think is “Socialist.”

        • We are no longer the same country. No ‘one’ is responsible. Collective responsibility has replaced individual. We really do all belong to the goverment now.

          Exhibit A is California. An eighth the population but a third the nation’s welfare reipients. Double digit unemployment (2nd highest in country) for years. Among the highest in taxation. Two out of three elective offices held by Dems including no statewide office by Reps. Accountability? Tuesday saw yet another blue sweep. What is the hope?

      • In other words, ‘tiredfred’, it’s still Bush’s fault. The weakest recovery in history, $1T+ deficits as far as the eye can see, the largest tax increase in history looming, etc – all his fault. Because if O/the Dems haven’t ‘fixed’ the economy, it can’t be. Less government – wishful thinking. The highest taxes on capital in the developed world – irrelevant. Greece beckons. Or California. Take your pick. Heck, I had about as much to do with the Great Depression as Hoover and the libs managed to dine out on that one for 60+ years.

    • When the credit markets get burned as badly as they did in 2008 (see reply in post above), the question is how long will it take to outlive the problem rather than how to fix it. That should happen in O’s second term regardless of what Washington does or doesn’t do. One change would help immediately: allowing underwater homeowners to refinance at lower rates. Conservatives have poor opinions of the unwashed masses, I know, but consider the nation’s worst housing market. On average, a Las Vegas home is worth about 60 percent of the mortgage financing it. Yet the great majority of homeowners continue to mail in their checks every month. Ayn Rand would give them a dope slap and tell them to mail in the keys, eh?

  3. As I recall, housing prices just started falling under their own weight. It’s as if personal debt to income reached a limit and the housing market suddenly turned south. And yes, oil prices took off like a rocket. At the time I figured oil prices alone were enough to trigger recession.

    • Wow, your rememberer needs work. Throughout the housing boom, investors bought trillions in mortgage backed bonds ($6 trillion in 2006 alone IIRC although much of it was refinancing that paid off trillions in existing bonds.) These were not subprime borrowers but your neighbors and mine tapping their home equity for the umpteenth time. Following the failure of the mortgage packagers in chief, Fannie and Freddie, bond buyers went on strike, unsurprisingly. The housing market limped into 2009, such as it was, only because the govt bailed out Fannie and Freddie and the Fed bought the agencies’ bonds: $1.25 trillion initially IIRC. The mortgage securitization market is still weak, and Realtors will tell you that, while you don’t have to be Harold Simmons to get a home loan, it doesn’t hurt.

  4. Keynesian economics is a big fat zero for merit. always will be. Why you ask?The tenants are not supported by the immutable laws that orchestrate human cognition and consequent choices and behavior.

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