Fiscal and not monetary policy should be used to reduce U.S. unemployment. While this would increase the federal deficit in the short run, we should learn from the lesson of Japan, which followed a more cautious fiscal path after a real-estate bubble collapsed in early 1990s. As a result Japan suffered a very long recession, and ended up with a much higher fiscal deficit, bringing public debt to two times its gross national product.
“Quantitative easing," QE, the Federal Reserve System’s purchase of more government debt designed to push interest rates lower, will fail to improve economic growth and reduce unemployment. While buying up government debt two years ago prevented a financial collapse and strengthened banks, another round of asset purchases isn’t the answer. Instead, a push from the fiscal side—rather than pushing interest rates lower—will get the U.S. out of sluggish economic growth.
Here’s why. Economic weakness is centered in the consumer sector, small businesses and state and local governments. Their problems cannot be resolved by lower interest rates. Home mortgage rates have already declined substantially, but the housing market is still paralyzed by foreclosures. Interest rates on general consumer credit have not declined along with market rates. Small businesses typically cannot obtain bank finance. These examples reveal that lower interest rates have done little to increase demand up to this point, so it is doubtful that further declines will accomplish anything.
The economy would be better served by measures to boost the incomes of those who spend essentially all of their incomes. If we can accelerate consumer spending on goods and services, then we will see faster growth in business spending, reduce pressures on cities and states and increase employment.
Consumer spending can be bolstered quickly and easily by instituting a holiday in employee payroll taxes. Ready-to-go targeted infrastructure projects that have been delayed by state and local or federal budget problems will also work. Both measures will initially increase the deficit—a legitimate concern. But the sooner the economy starts to grow more quickly, the sooner tax revenues will expand and recession-related federal spending will decline. Faster economic growth truly is the key to reducing fiscal deficits.
Let’s focus on ways to accelerate consumer spending to reduce unemployment and allow growth in tax revenues to restore our fiscal health. Fiscal efforts now are an investment in our future.
Marcelle Arak is professor of finance at the University of Colorado, Denver, and Sheila Tschinkel is principal, SLT Finance and Economics, Atlanta, and former director of research at the Federal Reserve Bank of Atlanta from 1985-96.