What Can We Blame?: Stimulus Doesn’t Stop Adjustment

Jason Furman
Jason Furman Aetna Professor of the Practice of Economic Policy - Harvard University, Nonresident Senior Fellow - Peterson Institute for International Economics, Former Brookings Expert

January 31, 2008

The following is in response to “Let the Economy Adjust” by Steven E. Landsburg in the Los Angeles Times.


You remind me a bit of the person who has only a hammer and for whom everything looks like a nail. You blame bloated government, badly designed taxes and an excess of regulation. I am a big fan of universal health insurance, Social Security reform, market-based solutions to global climate change, a two-state solution to the Israeli-Palestinian conflict and more funding for particle physics. But I am not suffering from the delusion that any of these are causing rising unemployment or that achieving any of my cherished goals would make a meaningful dent in the economy in 2008.

There is a simple reason why your diagnosis, and thus the remedy you prescribe, is implausible. All of the factors you cite have been relatively constant. They, together with many of the items on my wish list, are very important for long-run growth, overall efficiency and the prosperity and living conditions of our children. They are all big, complicated and controversial topics. But none of them has very much to do with the business cycle.

In the early 1980s the unemployment rate rose to almost 11%. In the early 1990s it rose to nearly 8%. It has increased 0.6% in the last nine months. None of these episodes can be explained by fluctuations in the design of the tax system or regulation. And even if we had the perfect tax, regulatory or health systems, we would still have business cycles if for no other reason than the “animal spirits” cited by John Maynard Keynes, which can lead to bouts of optimism and pessimism, driving consumer spending and investment up and down in ways that get propagated into business cycles.

Housing certainly is the primary culprit, but problems have spread well beyond that market. The associated problems have led to declining consumption and a credit crunch that threatens to reduce lending for a variety of productive activities. Employment in jobs related to residential real estate, including construction, has fallen by 264,000 in the last year — at the same time total unemployment has risen by 895,000. That is why the Federal Reserve, which traditionally avoids trying to target policies at individual sectors of the economy, is so involved. And it is why the odds of a recession, defined as “decline in economic activity spread across the economy” (emphasis added) have risen.

Economists are very much divided on the question of how to increase the economy’s productive capacity over the long run. But there is near universal agreement (and if it were not for you I probably would not have needed the word “near”) that when the economy is operating below its productive capacity the problem is insufficient aggregate demand, and the solution is to temporarily boost spending or investment through monetary or fiscal policy.

Such a solution prevents needless suffering but does not impede the adjustment you rightly note is needed. As I pointed out Wednesday, during the roaring 1990s the economy lost 252 million private sector jobs as a result of closing establishments or downsizing. But the economy was successful because it created 274 million new jobs — meaning that a low unemployment rate coincided with a dramatic shift in the makeup of U.S. jobs.

We can debate whether the economy is slipping into recession or about to rebound. We can debate whether the best tools are for the Federal Reserve to cut interest rates or Congress and the president to apply fiscal stimulus. And we can debate the most effective forms of fiscal stimulus. But to argue that the downturn could be solved by temporarily permitting discrimination against people with disabilities is just daft.


Will the economy get a much-needed boost from a stilmulus package? In a week long Los Angeles Times ‘Dust Up’ series, Jason Furman, a Brookings scholar and an advisor to President Clinton, and author-economist Steven E. Landsburg discuss the U.S. economy and the recently announced stimulus package.