The Democratic presidential candidates have elevated a host of big ideas this primary cycle and, in doing so, have challenged decades of conventional wisdom in US policymaking. As press and pundits warn of an imminent recession, it is time for them to take on flawed assumptions that have guided the mismanagement of our macroeconomy for the last 30 years.
Released earlier this year, an issue brief by Roosevelt Fellow and macroeconomist JW Mason argues that policymakers have consistently gotten it wrong on a number economic questions. Specifically, they’ve overestimated the costs of public debt, they’ve underestimated the costs of weak demand, and they have generally erred on the side of under-shooting demand, as opposed to overshooting it. We now stand on the threshold of a recession, without having had much of a recovery since the 2008 financial crisis. Whether GDP contracts or remain at the current level of weak wage growth and sluggish private investment, our economy and society need more public spending.
First, we need to let go of the notion that public debt is always bad. Building on the work of economists like former International Monetary Fund (IMF) chief economist Olivier Blanchard and former Obama-era Council on Economic Advisors (CEA) chair Jason Furman, Mason argues, in the current economic environment of low interest rates, there is no need for the debt-hysteria—which shaped public debate in the wake of the Great Recession and encouraged lawmakers to cut spending far too early in the recovery. Mason demonstrates that economists and policymakers have consistently over-estimated the costs of increased debt, while today, the debt-to-GDP ratio stands well above numbers that were previously viewed as catastrophic—and financial markets are very happy to buy long-term US debt.
The real concern: Our economy has been running well below potential. Running an economy hot—i.e., at or above potential—means that all of our resources are utilized, investors have lots of opportunities, workers have lots of choices when it comes to work, people who have left the labor force come back off the sidelines, and wages start to rise. Because resources are all being used, firms need to learn to do more with less, a phenomenon that can drive productivity increases. As Mason shows, 10 years after the financial crisis, with low headline unemployment, GDP still isn’t back on its pre-recession trajectory. The costs of operating below potential are measured in individual tragedies of unemployment or under-employment. Weak demand has helped to drive the long-term decline of labor share of income. But also, economists like Larry Summers and Lawrence Ball have identified high costs to the overall economy—when unemployment remains too high for too long, people lose skills and we erode our long term potential.
Despite these costs, policymakers, the Federal Reserve (Fed) and pundits have consistently allowed the economy to operate below potential to allegedly avoid the phantom costs of debt and inflation. US GDP has operated at least 2 percentage points below potential in at least 10 of the last 30 years, while operating above potential for only six months. During her spectacular questioning of Fed Chair Jerome Powell earlier this summer, Representative Alexandria Ocasio-Cortez (D-NY) elevated just how flawed estimates of full employment have been. Since 2014, the Fed claimed that full employment (the unemployment rate that would trigger inflation) was first 5.4 percent, then 4.5 percent, then 4.2 percent. Today, at 3.7 headline unemployment, wages are just beginning to move upward, and runaway inflation has yet to materialize.
It is essential that any candidate for federal office—and the journalists who cover them—grapple with the errors of our past and adopt a new understanding of macroeconomic management. For 30 years, we have made the wrong trade-offs—worrying too much about debt and inflation and not enough about investment and wages. If we truly learned the lessons of the past, the question should no longer be “How will you pay for it?” but “How will you ensure that our economy is reaching its full potential?”