Let’s put politics aside. Let’s assume we could fix what we wanted to. The problems we have are grasp and clarity. With the financial factors in the recession, the two tangible grasp points are on the consumer side: Consumers have too much leverage; and on the business side, it’s exactly the opposite: Non-financial corporate America has tons of cash.
Ezra Klein: Growth is weak. Unemployment is high. By almost any measure, the recovery has been very, very slow. What’s holding us back?
Glenn Hubbard: Let’s put politics aside. Let’s assume we could fix what we wanted to. The problems we have are grasp and clarity. With the financial factors in the recession, the two tangible grasp points are on the consumer side: Consumers have too much leverage; and on the business side, it’s exactly the opposite: Non-financial corporate America has tons of cash. So with that, the right thing to do would be to quickly de-lever consumers and change the animal spirits of businesspeople. On the consumer side, that could mean a big housing push, and on the business side, a big change to corporate tax rates or something else that increases the return on investment.
Then there’s a complete lack of clarity in three important areas for government policy: The path of future tax rates. The path of government spending, which is obviously related to tax rates. And the third is regulation, financial regulation in particular. And the lack of clarity in those areas has frozen business.
EK: Let’s focus then on the businesses. My understanding is that they’re sitting on the cash for two reasons. First, they don’t see a good reason to spend it. The possible investments are just not attractive enough. Second, they worry about another recession or crisis, perhaps driven by Europe. So what would we need to get them to spend?
GH: That’s why I say we need a radical change. I mean something dramatic. When I talk to business leaders, they see a lot of policy risk, a lot of fear about the business situation, and so you need to really change their views on the consumer sector and on rates of future return. For that reason, you need to do businesses and households at the same time. One thing to do is mass refinancing for home mortgages. On the business side, a big corporate rate cut would dramatically improve the profitability of future investments. So do them at the same time and you really give the economy a kick-start.
EK: I’m a big fan of mass refinancing. But even in the more optimistic analyses I have seen, it’s a boost of $70 or $80 billion per year for the economy. That’s important. But it’s not significantly larger than, say, a payroll tax cut. And some argue that the tax cut is better targeted, as a lot of the people laid off and hurt during the recession either never owned houses or don’t own one anymore. Do you disagree with them?
GH: Depends on what you do. I think the administration’s refinancing plan is pretty small beer. If you do all of what Chris and I suggested, it’s $70 billion a year. Is that enough to right the American ship? No. But can it change the consumer psyche? Possibly. And remember, it’s not specifically permanent, but because mortgages are long, it’s as close to permanent as you get in tax policy. It’s over many years. So it’s more akin to a permanent payroll tax cut. That makes it much bigger [than a one-year payroll tax cut].
EK: Let’s talk about policy uncertainty for a second. It often seems to me that when people talk about policy uncertainty, they actually mean “I’m uncertain about getting the policy I want.” Republicans, for instance, have preferred policy uncertainty to plans with tax increases. The Democrats also talk a lot about the boost in business confidence that would come from a debt deal, but they haven’t been so interested in certainty that they, say, passed Rep. Paul Ryan’s budget. It seems if the two sides actually cared about certainty, we would already have passed the Bowles-Simpson deficit plan.
GH: I agree. And I’m not saying I endorse everything in Bowles-Simpson. But if what you mean by that is passed something that clarified tax policy and spending policy in a reasonable way, then definitely. Both sides make the same mistake on this. It’s really the uncertainty, the wondering how we’re going to change the entitlement system or the tax system, that affects me today. That’s what’s lost on both sides. If you took Bowles-Simpson and made a change to dividend and capital gains, left it more as they are today, I would say fine. And for the life of me, I don’t know why Republicans don’t at least consider it as a marker.
EK: How much control do we have over the situation? That is to say, if we followed the path you lay out here, but Europe doesn’t solve its problems, how much better can things actually get?
GH: I do think if the Europeans get their act together, which means German taxpayers step up, we can muddle through fairly well. But if they don’t, and they slip into recession, the chance of us having good growth in the next few years is quite small. But to be clear, the European situation is not beyond their grasp. They can set up a European Financial Stabilization Fund that’s big enough to do the job, and the European Central Bank can buy a mountain of peripheral European sovereign debt to limit contagion during the Greek restructuring.
EK: And what if they don’t? Is there an appropriate contingency plan for us? I worry that this will be like the period between Bear Stearns and Lehman, where we had time to try and fortify our defense, but we did nothing.
GH: I would hope that the Treasury and Fed are going through exercises of what they might do. Fed can be active on the dollar-swap market and coordinating with European Central Bank. Treasury should be working with financial institutions. But unlike in 2008, individual institutions are already very wary. They have been reducing their exposure to Europe already.
EK: So the fact that we have been on crisis footing for a few years might actually help us.
GH: I think so.
EK: To what degree do you consider our current problems structural, in that they predate the financial crisis and, perhaps, were covered up by the credit boom in the Aughts?
GH: We have had a problem going back beyond the recession that the economy had become excessively dependent on consumption and not sufficiently on investment and exports. Some of that was because policymakers tried to help middle-class families by adopting policies that boosted consumption rather than dealt with the underlying trends that were making the long-term wage growth look not so good.
EK: So what should we do about that?
GH: Right now, for instance, I could see a lot of arguments for targeted infrastructure investment. What we don’t need is an industrial policy, but we do need to untie the hands of American manufacturers. Corporate tax reform. Regulatory issues. Litigation. None of it is a silver bullet, but it would help. At the same time, if you added an infrastructure plan and kept education and research funding at a high level, we could turn this around.
By Ezra Klein, Wonkblog, The Washington Post
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