A Coordinated Economic Stimulus Policy for the U.S.
Despite positive United States economic growth since the third quarter of 2009, job growth continues to be weak, indeed negative until recently. Separately, I have argued that the Fed should be patient and wait for households to rebuild their balance sheets, a process that will take quite some time to complete, and probably can’t be accelerated much.
I now offer an economic stimulus policy program for the United States that provides for a more activist stance than my previous argument. This is because current policy efforts appear inadequate and unlikely to change in the near future. This policy suggestion attempts to consider local and federal policies together as a complete package.
The United States economic doldrums are serious enough that an economic stimulus package must be coordinated with respect to fiscal and monetary policies, as well as with respect to local, regional, and national policies. I rely on economic theory and sometimes utilize a distinction between the short-run and long-run. Economists believe that incentives work, thus many of the recommendations have to do with reducing market distortions, (taxes, price supports, etc), that reduce incentives.
I start with housing, since that was the bubble, and the recognition that the sheer size of remaining foreclosures, over 3 million by most calculations, remains a large festering sore in the United States economy. A straight trend-line fitted to the currently falling home ownership rate puts mid-2012 as the earliest we could expect the home ownership rate to fall to a level that is historically necessary for a healthy housing market, about 64 percent. What this market needs is those households, who cannot afford the house that they are in and those who want to walk away from an upside-down home, make the transition from living in ownership-housing to rental-housing as quickly as possible.
Here is where I believe that the Fed should be buying things: houses. I have blogged on this before with Bill Watkins. Fed purchases of houses, especially distressed properties, would promote the fall of the home ownership rate and provide much needed support to a market that has seen demand plummet. Those houses would be cleaned up and rented out, providing an increased supply of rental housing. It would benefit distressed-property laden neighborhoods and housing values by reducing the extent of squatters and unkempt lawns and buildings.
What would the size of this operation be? The average price of a United States home was about $217 thousand in 2009. If we assumed the Fed paid $220 thousand per home and bought 3 million homes, (the same 3 million referred to earlier in the housing section), they would need to spend $660 billion. The Fed’s balance sheet increased from a bit under $1 trillion in mid-2008 to just under $2.5 trillion by mid-2010, a rough difference of $1.5 trillion. $660 billion could be too large, given where we are now, but it is still less than the proposed QE2 program. The housing market would experience a noticable boost if they only bought 1.5 million homes, just $330 billion dollars. The Fed’s balance sheet would then be just over $2.5 trillion, about 14 percent larger than now.
The Labor Market
Today’s labor market is characterized by historically high unemployment, a huge long-term unemployed cohort, and weak job growth. Our current forecast of the mid-2012 unemployment rate is eight percent. In moderate recessions, the recovery gains strength via positive-feedback from a resumption of job growth that circulates wage income and expenditures back into the economy. This positive-feedback does not yet exist in the current recovery.
The labor market would be improved through reducing the minimum wage, and through reducing marginal income tax rates. Top marginal income tax rates should be reduced at the Federal and State levels. Well-known economic theories help us understand that a reduced minimum wage will increase employment through demand and that lower income taxes also increase employment trough supply. These effects would not likely be as big as they would be in a recovery from a less-severe recession, but even small positive forces would be welcome in today’s labor market.
Banking continues to be very weak, with ongoing bank failures and bank charge-offs at historically high rates, and the weaknesses are likely to continue at least into mid 2011. I note that much has been written about the seriousness of the banking problem, including by our own Bill Watkins. A healthy banking sector is necessary for a robust recovery and for efficient monetary policy.
The large problem banks, which may be be all of the large banks, should be nationalized, a topic that Bill Watkins has written on at least once in the CERF blogspace. Once cleaned and broken up into smaller banks, they would be resold back onto the private market.
QE2 is not likely to do much, except to contribute to the dollar’s weakness. If left intact at all, I would recommend revising QE2 to only the purchase of mortgage securities, especially tranches of mortgages dominated by distressed assets. This would help those financial institutions who were not nationalized (see “Banks” above) but who had chunks of bad mortgages on their books, in effect accelerating and monetarizing already on-going activities. This would have the benefit of reducing uncertainty and shortening the transition period.
Suspension of the implementation of the Frank-Dodd bill should also be considered. This legislation, which even top economists do not fully understand, does not address the too-big-to-fail problem or the separation of risky activities from insured activities. This important legislation should be considered very carefully prior to implementation, and only implemented in a strong economy
A key aspect of a successful economic policy is to promote small-business growth. Thus the last financial markets recommendation is to ease costly regulations for smaller companies. A well-known example is Sarbanes-Oxley, which is a cost-center for a small bank that can’t maintain the compliance resources of a large bank. Eliminating Sarbanes-Oxley for small banks would provide direct stimulus to them, stimulating small-business activity through lower lending costs.
With problem banks nationalized, the interest rate on excess reserves, which might be restricting monetary policy, could be reduced or ended. This could marginally promote lending and economic growth, and it would help level the playing field for small versus large businesses.
My fiscal policy recommendations mainly consist of reducing marginal tax rates and providing business growth incentives. Given political realities, a reduction of government expenditures to balance the budget is probably unrealistic. Therefore, in the short run the debt to GDP ratio will rise. Once the economy is again healthy fiscal conservatism could return, reducing the deficit to GDP ratio.
Reducing various tax rates would incentivize business growth and then lead to improvements in the labor market and the economy. I recommend reductions in the capital income and capital gains tax rates and implementation of an aggressive investment tax credit. These are national policies.
At the state level, I recommend reducing gasoline and diesel fuel taxes, reducing top marginal income tax rates while broadening the tax base, and a through review of regulations with an intent of eliminating those that most impact economic growth. Both households and businesses would benefit from this, through reduced costs, and increased economic activity. We should reduce natural gas and electricity taxes as well which would benefit business activity and feed into Labor Market improvements.
At the municipal level, I recommend reducing real estate development fees, reducing business licensing/startup fees, reducing ongoing fees to businesses, and reducing the delays in permits and licenses. These changes will benefit small businesses and increase local economic activity.
United States immigration policy should be less restrictive. We should significantly increase the immigration of highly-educated and high-skilled workers. The resulting increase in population growth would add to the demand for housing and goods and services, slow the aging of our population, reinvigorate our cities, and promote new business formation.
The United States Dollar
Here I distinguish between the short run and the long run. The dollar is a freely floating market price, influenced by demand and supply, as well as expectations of the future health of our economy and the economies of our trading partners.
In the short run the value of the dollar might fall some, due to above-mentioned policies that are designed to promote growth, particularly the fiscal policies that would likely reduce tax revenues. This would benefit United States exports but only to a small extent given slow worldwide economic growth.
These polices would promote economic recovery, growth, and longer term health. Then in a few years, policies should be changed to those more consistent with a normally functioning economy. These things together, reductions in the deficit to GDP ratio, a stronger/healthier economy in a structural sense and a more rapid GDP growth rate, would naturally boost the dollar. Therefore, no dollar policy is necessary.