Laurence Kotlikoff proposes a prescription to cure the nation’s economic ills through monetary and fiscal policy. The American economy has been mired in a prolonged period of stagnant growth, and current leadership has shown little forethought and reason, instead harboring recycled, outdated ideas. On two points, the Kotlikoff’s proposal is completely on the mark; two others need to be reworked, and the final is not sufficiently comprehensive. Kotlikoff has offered a good start, but does not take his ideas far enough. Even bolder moves are required to reinvigorate this sluggish economy and bring America back to her rightful status as the leading economic engine in the world. The Federal Reserve can employ new ways of using of its tools through monetary policy, and the Government can find new expenditures to create aggregate demand in order to spur needed growth.
The strongest policy Kotlikoff offers compels the Fed to eliminate the practice of paying interest on excess reserves held by private banks, as the current policy establishes a disincentive to lend. The Federal Reserve pays 2.74% interest on the excess funds help by private financial institutions. Considering that financial institutions brought the global financial system to virtual collapse, rewarding banks with such an interest rate from the Federal Reserve appears to be untimely. Given the current economic climate, banks have reached the reasonable conclusion that receiving 2.74% interest is more profitable than finding good investments in the economy and loaning the money. Reducing this interest rate will compel banks to do what banks are supposed to do: loan money. Banks that are skillfully managed will be successful and those that are not skillfully managed will fail; their assets will be purchased by successful banks. Only this time, allow the invisible hand to work its magic without the guarantee of Uncle Sam flying in on a red carpet to bail everyone out.
The removal of the current interest rate would be particularly important with the passage of Dodd-Frank in 2010, which altered the margin requirement—that is; the percent of demand deposits banks can lend on the balance. In other words, banks could previously lend 97 cents of every dollar deposited, but Dodd-Frank changed the requirement to 7%. This created a vacuum of reduced loans from the baking system, and there was no provision to make up for the deficiency created by the new law. Eliminating the interest rate charge to banks would make up for that deficit and spur economic activity.
Kotlikoff’s proposal is a good start; however, a more targeted, sophisticated proposal would produce the desired economic outcome of moving toward full employment. We have seen in three years that traditional Expansive policy has had little affect on Economic Activity. At this point, Quantitative Easing has done little to jumpstart this lagging economy. Monetarists would expect increased lending from banks as businesses and households have cheaper prices; on the contrary, banks simply allow funds to sit in their balance sheets. With a decrease in the interest rate paid to banks for excess funds, banks may take the money make loans to other financial institutions or large companies who have taken the “cheap” money to pay down their long-term balance sheets. This will improve stock prices, but have little to no impact on moving toward full-employment. Instead of eliminating the interest rate, attach stipulations when the Fed lends money to banks. Maintain the discount rate, reduce the interest rate, but put the excess funds to the banks for a certain time period. Give the banks a year to find lending for funds, at which point they will no longer receive interest in the funds. Banks will be allowed to return the excess back to the fed at the end of the year if they wish to. Successful banks will find appropriate ways to invest the excess funds into projects; failing banks won’t be able to compete and will be susceptible to bank takeover or failure.
The author’s second proposal is a less attractive alternative: The government should not be in the business of telling companies what to do with their payroll, employment practices, or hiring quotas. Incentives through tax benefits and rate considerations are acceptable free market manipulators in free market societies. However, is there a slim line between targets and mandates? Companies should hire because an increased demand for each additional worker—that is marginal utility, is warranted under the price level. It is against all free market principles to use the president to dictate hiring practice to corporate America. Though the use of bully pulpit is within the range of acceptable options for the leader of the free world, dictating actual numbers would be a ridiculous situation to navigate.
The author completely ignores the paradigm of the new global sensibilities in regard to what a global company would entail. First, Kotlikoff contends that workers should initially finance the extra hiring of other employees, for the good of the country. He supports this assertion with the example of the program of volunteering, adopted national job-saving measure that Germans rallied together to support their economy, making it the envy of the world. First, what is even considered American? Whether the business is incorporated in the United States, or the percentage of American workers it employs? The definition is vague in today’s global economy. Second, the difference of the American population in comparison to German society is vast. Germans are a nationalistic, homogeneous population that coalesced for the good of the country. The author also errs in his analysis that the German economy is the envy of the world; this statement may have been accurate a year ago. According to economist Michael Schroder of the Mannheim-based Zew Survey, “[German] economic sentiment has fallen to its lowest level in three years, and Germany may already be in a recession” (Marsh, October, 2011).
Again, Kotlikoff’s third point is just as flawed because the CEO’s of the 1000 countries cannot limit the investment to the United States. If China is growing at 9.2 %, India at 10%, and Brazil at 9.3%, companies will place resources in areas that produced the most wealth for shareholders (Jones, personal communication, October, 2011). Companies are not benevolent social organizations that are responsible for increasing demand or providing full employment for the nation’s economy.
His fourth point is equally flawed; the so-called shovel project did not lead to enough spending to create enough increased output to make a dent in the recession. Theoretically, a more substantial project may have made a more substantial dent in the overall output. However, the stimulus was one fifth of the amount that could have made a successful impact, according to many leading economists. Critics have summarily dismissed the stimulus as a complete failure. The country may have in fact approached depression level contraction in the overall output of the economy. The definition of a recession is four consecutive quarters of contraction from the US economy. Subtract the trillion-dollar stimulus we may have qualified as the worst depression since the 1930’s.
Although the author is correct in his analysis of addressing the problem of “sticky” wages, this undertaking would be a waste of resources in both the short run and the long run. As an example, Kotlikoff proposes to repeal the 1931 Davis-Bacon Act, which requires contractors using federal spending on much-needed infrastructure projects to pay no less than the locally prevailing wages. Kotlikoff asserts that this measure would create jobs, but again, these are band-aid remedies that do not significantly shift the demand curve outward. Some temporary increase in aggregate demand may shift the curve; however, at best, this is a short-lived, temporary remedy.
Moreover, this proposal is essentially not politically viable. The AFL-CIO, carpenters, electricians would use all political capital to prevent the Act’s repeal. First the teachers’ union would bind together and declare that they would not work in a building not built with union toil. Second, the industrial Midwest—Detroit, Chicago, Pittsburgh, and Ohio—would make it political suicide for any candidate, Republican or Democratic, to be elected. The Northeast would quickly follow suit—Boston, Philadelphia, and New York would make it politically intractable for any congressman to be considered for any type of political office.
Finally, Kotlikoff addresses the most ominous problem to full employment—expectations. Radical reform in the areas of the tax code, Social Security, and health care are crucial in creating any sustained growth for the U.S. economy. Psychological demand from consumers and businesses is a concept not readily addressed by fiscal or monetary policy. Currently, companies have larger balance sheets and are more fiscally sound than they have been in years. However, hundreds of millions of dollars remain idle, not invested in land, capital, or labor in the general economy.
Private industry contends that despite their strong balance sheets, the reluctance to invest in the U.S. economy is due to the uncertainty in the tax code and overregulation. In a recent Gallop Poll, the question of what small businesses want was posed to small businesses. Steve Coleman, CEO of Drankenton, exclaimed, “The message of anti-business out of Washington is putting a wet blanket on any potential recovery. We just need to know what the next several quarters are going to look like” (Forsyth, October, 2011).
Similarly, households are suffering from a psychological demand deficit. Despite Americans having paid millions of dollars in debt off over the past few years, there remains an absence of a clear signal from Washington on the issue of fiscal policy. Charles Cobb, President of the Committee of Economic Development, spoke in front of policy makers at the Waldorf-Astoria and stated, “Traditional fiscal stimulus will not be effective as long as the American consumer is worried about the price of their home and whether they will have the money to afford it; this is why the recession is very different from the rest… Housing will continue to put a drag on fiscal stimulus” (Forsyth, October, 2011). As long as American households see the value of their homes continue to fall, psychological demand will continue to discourage Americans to spend, which the consumption component accounts for a large percentage of GNP.
Fiscal policy needs to be targeted at improving the housing market, with the bold move by the government to purchase a percentage of the two million surplus houses in the market. Housing prices will continue to fall as long as an excess of supply continues to pull down the value of homes in the market. Between the overbuilding in the late 1990’s and early 2000’s, and the continued glut being injected into the housing system, the situation continues to weigh down on housing prices.
According to Fiserv, a financial analytics company, home values are expected to fall another 3.6% by next June, pushing them to a new low of 35% below the peak in early 2006, marking a triple dip in prices. David Stiff, Chief Economist for Fiserv, stated that several factors would be working against the housing market in the upcoming months, including an increase in foreclosure activity and sustained high unemployment. Additionally, Mark Dotzour, an economist for Texas A & M University, states that there are six million homes currently in shadow inventory. Presumably, this could prove to be the “pink elephant in the room that could propel another recession” (Christie, October, 2011).
The proper prescription to heal the economy is to purchase 50% of the excess housing inventory in America. The initial proposal from President Obama was upwards of a four trillion dollar stimulus; eventually, Congress agreed upon a plan closer to one trillion. Many economists believe the stimulus may have been more successful if closer to the originally proposed four trillion had been spent. However, the President, with the bully pulpit at his disposal, makes an impassionate plea to the American people. His selling point: Your home value will increase. Borrow one trillion dollars and purchase one million homes: 50% of the current glut of new constructions, inventory that has been foreclosed, and homeowners underwater who walked away.
With the home purchases, relax the archaic immigration policy and potentially bring in billions in tax revenue by selling these homes to current illegal immigrants and attracting new immigration. It has been estimated that over a trillion dollars of unreported income is produced from the labor of illegal aliens. Allow this underground stimulus to enter the business cycle, and an outward shift of the demand curve would result. Additionally, the increase in tax revenue will help the OBM’s balance sheet.
Monetary policy must prioritize the buying of additional mortgage-backed securities. At the start of 2009 the Fed began the process of buying securities, which has currently reached 1.25 trillion (Cooke, November, 2001). Fed Governor Tarullo stated, “I believe we should move back up toward the top of the list of options—the large scale purchase of additional mortgage-backed securities” (Reuters, October, 2011). This, coupled with Operation Twist, lowering the discount rate to .25%, and the continued purchase of short-term securities will ease the burden of bad debt on the balance sheets of private banks and quasi-government/private entities such as Fannie Mae and Freddie Mack, ultimately reliving the burden the housing crisis of 2008 has placed on the United States’ financial institutions.
Additionally, monetary policy may need to continue policies that promote debasement of the United States currency. Currency debasement is a complicated manner for even the most seasoned Economists. The Swiss-Franc at the height of the European debt crisis was appreciating at such a fast rate that any measures their “Fed” took to ease the strength of the currency were unsuccessful. However, “printing” money by the Fed, coupled with high unemployment and low anemic economic growth, support a weakening dollar. The weakened dollar makes the United States exports more attractive to foreign investors. Historically, the dollar has been one of the strongest currencies traded in the Forex market. However, the change has presented opportunities for savvy investors from around the world.
Quantitative easing of the money supply by the Federal Reserve has contributed to the debasement of the dollar, producing substantial increases from foreign investment in the United States housing industry. Foreign investment accounts for 82 billion dollars, according to the National Association of Realtors (Robb, October, 2011). This foreign investment continues to be one of the only lifelines thrown to a fledgling housing market. The Fed’s active role through quantitative easing has spurned an environment for “cheap” money. Consequently, the flood of cash into the economy continues to drive down interest rates and partially contribute to the weakening of the U.S dollar. Incidentally, the budget crisis and looming deficit reduction panel may continue to reduce some global confidence in the greenback. Thus, “producing or taking advantage of their 1.4 to 1 exchange advantage or merely their substantial saving and investing in the safety of the U.S. housing market” would be a sound investment, noted Wei Min Tau, real estate broker from Charles Rutenburg Realty (Cooke, October, 2011).
The increase in foreign investment could additionally reduce the excess supply of housing not purchase by the government through my proposal. Currently, Brazilians are buying one in three condos in Miami. A real estate broker quipped, “You have all these brokers running out buying Rosetta Stone to learn Portuguese” (Forsyth, October, 2011). Continued purchasing of real estate property would shift the supply curve to the left, essentially raising the price level. Additionally, demand would increase when the new “population” of foreign consumers enters the job market. Finally, and most importantly, psychology of demand would improve expectations in the housing; thus shifting the demand curve to the right.
The new bill in Congress suggests that some in Washington may agree with my proposal. Charles Schumer and Mike Lee have co-sponsored a bill that will grant visas to foreign investors buying $500,000 worth of real estate. “We feel they will sop up the excess supply of homes we have right now that has been dragging down the economy” (Forsyth, October, 2011). The Senate has proposed an outside-the-box approach to fiscal policy to tackle the biggest deterrent to any real growth.
In his successful 1992 campaign bid, Bill Clinton echoed repeatedly, “It’s the economy, Stupid!” My message to Professor Kotlikoff, “It’s housing, Stupid!” Fiscal and monetary policy can be used to bolster the lagging US economy only by addressing the greatest obstacle to growth: housing. The largest single investment most Americans make in their lifetime is the purchase of a house. As long as they see the value of that investment continue to plummet day after day, most will use disposable income to pay down debt rather than spend money. Heed my suggestions and have a little faith.
