It was the worst Fed decision since the Great Depression. On Sept. 15, 2008, Lehman Brothers filed for Chapter 11 bankruptcy protection. The stock market was already down some 15% since May. The National Bureau of Economic Research later declared a recession had started at the end of 2007, one that by late summer 2008 was intensifying. And as Scott Sumner has pointed out, the market forecast of inflation over the next five years had plunged to an annual rate of only 1.23%.
America needed aggressive monetary easing, ASAP. But at its Sept. 16 meeting, the Federal Open Market Committee stood pat, as it had since April of that year when it cut the federal funds rate by 25 basis points to 2.00%. The release of 2008 FOMC meeting transcripts shows what a disaster that meeting was. Here, for instance, is St. Louis Fed President James Bullard:
This is part of an ongoing shakeout among financial market firms, following some of the worst risk management in a generation. I expect sluggish growth in the second half of 2008, in part due to labor markets that are somewhat weaker than expected. Financial market turmoil is certainly a key concern, but the U.S. economy still outperformed expectations in the first half of 2008, despite the demise of Bear Stearns—an event not too different in some respects from the current episode. … Meanwhile, an inflation problem is brewing.
Sluggish growth? Brewing inflation problems? Not so much in reality. Boston Fed President Eric Rosengren, who voted to cut rates, was more on the mark:
This is already a historic week, and the week has just begun. The labor market is weak and getting weaker. The unemployment rate has risen 1.1 percentage points since April and is likely to rise further. I am not convinced that the unemployment rate will level off where the Greenbook is assuming currently. The failure of a major investment bank, the forced merger of another, the largest thrift and insurer teetering, and the failure of Freddie and Fannie are likely to have a significant impact on the real economy. Individuals and firms will become risk averse, with reluctance to consume or to invest. Even if firms were inclined to invest, credit spreads are rising, and the cost and availability of financing is becoming more difficult. Many securitization vehicles are frozen. The degree of financial distress has risen markedly. Deleveraging is likely to occur with a vengeance as firms seek to survive this period of significant upheaval.
Instead of weighting heavily forward-looking market measures such as inflation-protected Treasuries, the FOMC got faked out by backward-looking government data. Imagine if the Fed in September 2008 had not only slashed rates but maybe also begun a QE bond-buying program to support a declared nominal spending target. We might not be marking the 5th anniversary of the Obama stimulus this week or lamenting the Not-So-Great Recovery.
And now history is rhyming. With inflation low and GDP growth sluggish, some are eager to end QE and hike interest rates. These folks fail to consider why US GDP growth accelerated last year despite considerable fiscal drag. They focus only excess bank reserves and not other channels such as higher asset prices and expectations. Failure to understand what went wrong in 2008 (and what’s gone right since) continues to foul the current Washington economic policy debate and makes another Great Recession/Depression more likely in the future.
Well, yes and no. In the short term, it would seem fiscal austerity would continue. President Obama proposes $56 billion in new spending, including money for manufacturing hubs, incentives for states to promote energy efficiency, job training, and expanded preschool. But this new spending would not be deficit financed. It would be paid for through some unspecified mechanism – though almost certainly by higher taxes rather than spending cut offsets. Goldfarb notes Obama has previously “proposed limiting the value of income-tax deductions for wealthy households and closing a variety of corporate tax breaks.” So likely more of the same.
More notable is the striking lack of urgency to do much about entitlement spending and the approaching tidal wave of related debt. This new budget proposal abandons the idea of calculating Social Security benefits according to a stingier inflation measure: the so-called chain weighted CPI index. Making the switch would reduce cost-of-living increases and cut Social Security’s future shortfall by 15%.
Now the demise of this idea is no great loss. Two big problems (beyond Obama’s progressive base hating it): first, this new inflation measure would do a poor job of accurately reflecting prices changes for seniors. Second, switching to chained CPI would be a big long-term, middle-class tax hike. By also lowering annual inflation adjustments to the tax code, chained CPI would, as AEI’s Andrew Biggs has noted, “reduce the value of credits and deductions and push a greater share of workers’ incomes into the higher tax brackets. Result: higher taxes, and particularly so on low and middle class households.”
Over coming decades, average tax rates and tax revenues relative to the economy would rise to record levels. Indeed, last year’s Obama budget would have theoretically balanced the budget in 2055 with tax revenue at 21.5% of GDP vs. the 17.4% postwar average. Republicans seem not to have noticed this.
So, bad idea. But Obama makes no bold new proposals to reform Social Security, Medicaid, or Medicare. Instead he bets that the recent slowdown — a large part of which the White House credits to healthcare reform — in medical spending is permanent. Obamacare is, effectively, Obama’s major entitlement reform. Goldfarb: “As a result, the White House projects annual budget deficits will fall below 2 percent of gross domestic product by the end of the decade. That outlook is much rosier than CBO projections, which show the deficit rising to 4 percent of GDP in 2024.”
So the Obama budget loses a certain tax hike and gains a possible spending cut. Progress?
A bit more than half of US healthcare spending goes to labor costs. So if the widely reported slowdown in healthcare spending is a secular trend, there should be a decline in healthcare employment, too. And there are some signs. Job growth in the sector the past years has been just half its longer-term average — and none at all, really, the past two months.
Here’s your trouble: projections about US future employment growth typically assume lots of healthcare jobs. But maybe less spending will mean many fewer future medical jobs. Indeed as Peter Orszag points out in his Bloomberg column, ” … if the job growth rate in health care after 2010 had continued at its historical average of 2.8 percent per year, the sector would employ some 650,000 more people today than it actually does.”
Of course, the point here isn’t to just to create lots of jobs by maintaining an inefficient status quo in the sector. Recall the famous Milton Friedman line about government ordering workers to dig with spoons rather than shovels (or machines) to create more jobs. Orszag suggests a way to keep employment growing while also improving value:
The way to square this circle is to shift the types of jobs within health care. The sector is replete with labor-market inefficiencies. One example involves scope-of-practice restrictions that prohibit professionals from undertaking particular tasks. Nurse practitioners, physician assistants, pharmacists and occupational therapists, among others, are capable of doing more than they are allowed to do — and letting them would increase value to consumers. To the extent that work shifts toward these types of health-care providers, employment in the sector can grow without a commensurate rise in costs. Indeed, encouraging this shift is a key way to promote better value in health care.
Anyone who remains skeptical that health-care costs are decelerating should take pause from recent job trends. At the same time, employment growth in health care need not remain so sluggish to keep the cost increases slowing. Instead, policy makers at both the federal and state levels should move aggressively to allow some types of health-care workers to perform all the tasks they are qualified to perform. Clearing away that underbrush would help to at once bend the health-cost curve and encourage employment growth.
US healthcare needs deregulation for many reasons and in many ways. But one key goal is to enable innovative new delivery models needed to create disruptive innovation of the sort that makes healthcare goods and services less expensive and more accessible. And nurses and other nonphysician providers have a potentially massive role to play in all this as medical technology improves.
In addition to powerful and useful AI, the other recent development that promises to further accelerate the second machine age is the digital interconnection of the planet’s people. There is no better resource for improving the world and bettering the state of humanity than the world’s humans—all 7.1 billion of us. Our good ideas and innovations will address the challenges that arise, improve the quality of our lives, allow us to live more lightly on the planet, and help us take better care of one another. It is a remarkable and unmistakable fact that, with the exception of climate change, virtually all environmental, social, and individual indicators of health have improved over time, even as human population has increased.
This improvement is not a lucky coincidence; it is cause and effect. Things have gotten better because there are more people, who in total have more good ideas that improve our overall lot. The economist Julian Simon was one of the first to make this optimistic argument, and he advanced it repeatedly and forcefully throughout his career. He wrote, “It is your mind that matters economically, as much or more than your mouth or hands. In the long run, the most important economic effect of population size and growth is the contribution of additional people to our stock of useful knowledge. And this contribution is large enough in the long run to overcome all the costs of population growth.”
House Ways and Means Chairman David Camp apparently plans to release details of a tax-reform package next week. National Journal on the issue of paying for deep rate reductions:
[Democrats] say Republicans gave them an ultimatum at a meeting last summer that they could be part of the process in writing the bill—that is, if they agreed to go along with lowering the corporate tax rate from 35 percent to 25 percent, and for top individual earners from 39.6 percent to 25 percent.
At the same time, Democrats say that plan did not contain specific ways to replace that lost revenue. The simple fact, according to Democrats, is that Republicans have not been able to make the math work—and to do what they want to do would add $5 trillion to the deficit.
On Thursday, Democrats said there was talk that Camp may have actually recently revised his own plan, so that his top rate may not be lowered below 30 percent, after all. But they say they expect gimmicks will be needed to pay for it, anyway. One big gimmick anticipated, they say, is expanding the Roth IRA, which could raise a lot of money now but cost a lot of money in the future.
As a result of the growth of entitlement spending, future revenue shares will probably be higher than the historical values. The revenue share could remain at current levels if health and Social Security spending were kept at their current shares of GDP. The CBO projections make clear, however, that keeping entitlement spending at its current share would require dramatic and ever-deeper reductions relative to the benefit levels implied by current policies.
Keeping these programs at 10.6 percent of GDP, rather than growing to 20.8 percent in 2063, for example, would require that benefits be cut in half from the level implied by current policy. The political feasibility of that strategy depends on the public’s willingness to support dramatic reductions in entitlement spending (relative to the levels promised by current policy) as an alternative to tax increases. Countless polls make clear that that willingness does not exist.
Any private sector forecaster who thinks the Fed would have allowed 2010 GDP to be about 2.7% less than it actually turned out to be needs to have their forecasting license revoked, that estimate is an insult to Ben Bernanke. He was not about to preside over another depression. Bernanke would have instituted price level targeting long before that outcome materialized. People working in this area need to have common sense about plausible outcomes, otherwise nothing they say will be taken seriously.
Second, the WH again neglects the Fed when talking about austerity and the US economy’s 2013 performance. Sumner:
They forgot to mention to big payroll tax increase, or the income tax increases, both occurred at the beginning of 2013. Quite a fiscal drag (the Economistmagazine estimated the effect at 1.9% of GDP, even without the shutdown), and yet RGDP growth accelerates from 1.95% in 2012 to 2.7% in 2013. Nor is there a discussion of the fact that fiscal austerity in the U.S. was slightly greater than in the eurozone in recent years. Yet the US economy did far better, solely due to the greater willingness of the Fed to do monetary offset.
Sumner’s bottom line:
Instead of comparing actual to predicted results, they have lots of graphs showing the success of fiscal stimulus based on models of the economy that simply assume the policy was successful. How is that supposed to convince anyone? … But I thought they might at least be able to come up with some plausible arguments to counteract conservative criticism of the program. Unfortunately they’ve failed at even that modest goal. They don’t even engage with their critics. This is by far the weakest economic recovery in my lifetime.
Recent years have made clear that the free enterprise system is under immense strain. But the answer is not simply to double down on budgetary arguments, tout low-tax solutions, and explain economic basics. We must stop considering free enterprise purely in terms of economic gain and wealth creation and begin considering it in terms of human fulfillment. In working with his Holiness the Dalai Lama, AEI seeks to create an open forum among scholars, social and political leaders, doctors, and scientists to discuss the ways in which material prosperity, spiritual development, and ethical leadership can maximize human flourishing.
Far from a talk, we look forward to a conversation with His Holiness about how the free enterprise system can offer the best path toward happiness when predicated on ethical leadership, morality, and compassion for others.
Panel I: Moral free enterprise: Economic perspectives in business and politics
Discussion: His Holiness the Dalai Lama Arthur C. Brooks, AEI Jonathan Haidt, New York University Glenn Hubbard, Columbia University Daniel S. Loeb, Third Point LLC
Panel II: Unlocking the mind and human happiness
(Cohosted by the Mind & Life Institute)
Discussion: His Holiness the Dalai Lama Diana Chapman Walsh, Massachusetts Institute of Technology Richard Davidson, University of Wisconsin Otto Scharmer, Massachusetts Institute of Technology Arthur Zajonc, Mind & Life Institute
His Holiness the Dalai Lama, Tenzin Gyatso, is the spiritual leader of Tibet. At the age of two, he was recognized as the reincarnation of the 13th Dalai Lama, Thubten Gyatso. His Holiness began his monastic education at the age of six. At 23, His Holiness sat for his final examination in Lhasa’s Jokhang Temple during the annual prayer festival in 1959. He passed with honors and was awarded the Geshe Lharampa degree, equivalent to a doctorate of Buddhist philosophy. In 1950, His Holiness was called upon to assume full political power after China’s invasion of Tibet in 1949–50. In 1954, he went to Beijing for peace talks with Mao Zedong and other Chinese leaders, including Deng Xiaoping and Zhou Enlai. In 1959, His Holiness escaped into exile. Since then he has been living in Dharamsala, northern India. In 1989 he was awarded the Nobel Peace Prize for his nonviolent struggle for the liberation of Tibet. He has consistently advocated policies of nonviolence, even in the face of extreme aggression. He also became the first Nobel laureate to be recognized for his concern for global environmental problems. His Holiness has travelled to more than 67 countries spanning 6 continents. He has received more than 150 awards, honorary doctorates, prizes, and the like in recognition of his message of peace, nonviolence, interreligious understanding, universal responsibility, and compassion.
Arthur C. Brooks is the president of AEI. Until January 1, 2009, he was the Louis A. Bantle Professor of Business and Government Policy at Syracuse University. He is the author of 10 books and many articles on topics ranging from the economics of the arts to applied mathematics. His most recent books include “The Road to Freedom: How to Win the Fight for Free Enterprise” (Basic Books, 2012), “The Battle: How the Fight between Free Enterprise and Big Government Will Shape America’s Future” (Basic Books, May 2010), “Gross National Happiness” (Basic Books, 2008), “Social Entrepreneurship” (Prentice-Hall, 2008), and “Who Really Cares” (Basic Books, 2006). Before pursuing his work in public policy, Brooks spent 12 years as a professional French hornist with the City Orchestra of Barcelona and other ensembles.
Richard Davidson is the founder and chair of the Center for Investigating Healthy Minds at the Waisman Center, University of Wisconsin–Madison, where he is also the director of the Waisman Laboratory for Brain Imaging and Behavior. He is also currently the William James Professor and Vilas Research Professor of Psychology and Psychiatry at the University of Wisconsin–Madison. He is the coauthor or editor of 13 books, including “The Emotional Life of Your Brain” (Penguin, 2012). He is the recipient of numerous awards for his work, including the Research Scientist Award from the National Institute of Mental Health, the Distinguished Scientific Contribution Award from the American Psychological Association, and election to the American Academy of Arts and Sciences. In 2006, he was named one of the 100 most influential people in the world by Time magazine; that same year, he received the first Mani Bhaumik Award from the University of California–Los Angeles for advances in the understanding of the brain and the conscious mind in healing. In 2011, he received the Paul D. MacLean Award for outstanding neuroscience research in psychosomatic medicine. He serves on the scientific advisory board at the Max Planck Institute for Human Cognitive and Brain Sciences in Leipzig, Germany; as chair of the psychology section of the American Association for the Advancement of Science; and has served on the board of directors for the Mind & Life Institute since 1992.
Jonathan Haidt is the Thomas Cooley Professor of Ethical Leadership at New York University’s Stern School of Business. For 16 years he was a professor in the Department of Psychology at the University of Virginia. Haidt is the author of more than 90 academic articles and two books: “The Happiness Hypothesis: Finding Modern Truth in Ancient Wisdom” (Basic Books, 2006) and “The Righteous Mind: Why Good People are Divided by Politics and Religion” (Pantheon, 2012), which became a New York Times bestseller. His three TED talks have been viewed more than 3 million times. His research focuses on morality — its economic foundations, cultural variations, and developmental course.
Glenn Hubbard, a former chairman of the President’s Council of Economic Advisers, is currently the dean of Columbia Business School. He specializes in public and corporate finance and financial markets and institutions. He has written more than 90 articles and books, including two textbooks, on corporate finance, investment decisions, banking, energy economics, and public policy. He has served as a deputy assistant secretary at the US Department of the Treasury and as a consultant to, among others, the Federal Reserve Board and the Federal Reserve Bank of New York.
Daniel S. Loeb founded Third Point LLC in 1995, where he leads portfolio management, risk management, and research activities. Before founding Third Point, he was vice president of high-yield bond sales at Citigroup. Previously, Loeb was a senior vice president in the distressed debt department at Jefferies & Co., where he worked as a bankruptcy analyst, bank loan trader, and distressed securities salesman. Before Jefferies, he was a risk arbitrage analyst at Lafer Equity Investors. Loeb began his career as an associate in private equity at Warburg Pincus. He is a trustee of the United States Olympic Committee, Mt. Sinai Hospital, the Manhattan Institute, and the Museum of Contemporary Art in Los Angeles. He is a member of the Council on Foreign Relations and AEI’s National Council. Loeb is a cofounder and board member of Students First New York, the state branch of the national education advocacy organization. He is the chairman of the board of three Success Academy Charter Schools and also serves as the chairman of its governing board. Since 2004, Loeb has been a trustee of Prep for Prep, a NYC nonprofit organization that prepares underprivileged children to attend competitive independent schools.
Otto Scharmer is a senior lecturer at the Massachusetts Institute of Technology (MIT) and founding chair of the Presencing Institute. He chairs the MIT IDEAS program and cofounded the Global Wellbeing and Gross National Happiness Lab. He is also vice chair of the World Economic Forum’s Global Agenda Council on Leadership. In his books “Theory U” (Society for Organizational Learning, 2007) and “Presence” (Society for Organizational Learning, 2004, coauthored with Peter Senge, Joseph Jaworski, and Betty Sue Flowers) he introduced the concept of “presencing” — learning from the emerging future. His new book “Leading From the Emerging Future: From Ego-system to Eco-system Economies” (Berrett-Koehler Publishers, 2013) applies mindfulness to the transformation of business, society, and self.
Diana Chapman Walsh, president emerita of Wellesley College, is a member of the Corporation and the executive committee of the Massachusetts Institute of Technology, and serves on the governing boards of the Mind & Life Institute, Broad Institute, Kaiser Family Foundation, and the Institute for Healthcare Improvement. She is an elected member of the American Academy of Arts and Sciences and was a director of the State Street Corporation (1999–2007) and a trustee of Amherst College (1998–2010). Before leading Wellesley College (1993–2007), she was professor and chair of health and social behavior at the Harvard School of Public Health.
Arthur Zajonc, president of the Mind & Life Institute, was a professor of physics at Amherst College from 1978–2012. He has been a visiting professor and research scientist at the École Normale Supérieure in Paris, the Max Planck Institute for Quantum Optics, and the Universities of Rochester and Hannover. He has been a Fulbright professor at the University of Innsbruck in Austria. His research has included studies in electron-atom physics; party violation in atoms; quantum optics; the experimental foundations of quantum physics; and the relationship between science, the humanities, and the contemplative traditions. While directing the Center for Contemplative Mind in Society, he fostered the use of contemplative practices in college and university classrooms. He continues to speak around the world on the importance of contemplative pedagogy.
At the top, we can see an elite doing well in a labor market offering big returns to human capital. This is perhaps not the just the top 1% (much though politics might be easier if that were so) but, say, the top decile, or 10%, of the income distribution. This stratum is not only prospering economically. For the people on this top rung, education levels are high and rising. Families are planned, marriages strong, neighborhoods safe and rich in social capital, networks plentiful, BMIs low and savings rates high.
Below this affluent class is a broad swath sometimes dubbed the ‘squeezed middle.’ This group have decent labor market participation rates, but wages that are rising slowly. In many cases, two wages are needed to support the family. They own a home, but are not otherwise wealthy. Savings exist for emergencies or one-off expenditures, but run out fast if the households has a serious downward shock to income. Private schooling is rarely an option, financially. (This is a group that might benefit from one of the schemes of wage insurances currently being discussed, most recently by Prof Miles Corak).
At the bottom of the social scale are those whose poverty is entrenched. Labor market attachment is weak, with many people in long-term unemployment. Teen pregnancy is still heard of, unlike in most communities today. Poverty is felt in most domains of life – crime, health, education, parenting, drug addiction and housing. The growing economic segregation of neighborhoods further isolates this group from chances of work, better schooling or valuable social networks. Upward intergenerational mobility rates are low.
And how will automation affect this trifurcation with policy intervention? Solidify the barriers between Affluent and Squeezed with the former skimming off the top bit of the latter? Worsen the mobility of the Entrenched, creating more zero marginal product workers and even less labor force participation? Much to think about here.