U.S. Economy Needs More Federal Spending, Yale Economists Say

As Yale University economists gathered on Thursday evening to discuss job growth strategies, many warned that a failure to act aggressively risks the increasing possibility of many years of economic stagnation, elevated joblessness and declining living standards.

Some suggested that the government must act quickly to put millions of Americans back to work with large-scale public projects, while warning that an inadequate response risks a U.S. fate similar to Japan's so-called lost decade.

After a collapse in housing prices and the stock market, Japan in the 1990s suffered from a deflationary spiral that the government and central bank enabled by not substantially increasing spending or lowering borrowing costs. Unemployment remained elevated as consumer spending declined, and both people's debt and goods and services became more expensive.

"Think about Japan in 1989. It was a global powerhouse which many people thought would be number one and dominate the world economy, and 20 years after ... it is off the economic map," said economist Aleh Tsyvinski. "I am afraid that we are on the verge of something much greater and much more problematic with the U.S. economy."

Economist John Geanakoplos said the current predicament must be viewed as a long-term problem that requires long-term solutions. He proposed that government officials set up expert committees to investigate how to remake American infrastructure for the next 10 to 20 years, building airports, trains and roads for the future rather than patching up old models.

In the long run, Geanakoplos said, infrastructure investment raises money for the government because those employed in construction and those using the new infrastructure spend more and pay higher taxes. Both the government's budget and the economy benefit, he said.

Economist Robert Shiller agreed with Geanakoplos' prescription for more infrastructure investment. "When we go through a crisis like this, it's a time for us to improve everything," Shiller said.

He suggested that the government create a Federal Employment Reserve Authority -- inspired by Yale economist Martin Shubik's 2009 proposal -- which would identify shovel-ready projects around the country that the government could invest in during recessions. Just as people cannot get over colds all at once, Shiller said, the government cannot bring the unemployment rate "rapidly down" if it does not prepare for the disease beforehand.

If the U.S. pinpoints shovel-ready projects before the next recession, Shiller said, "We'd have some medicine in the medicine cabinet ready to use, rather than having to make a long trip to the drugstore late at night, which you don't do. You'll just go to bed and suffer."

Some economists said that the U.S. is in danger of rising social unrest and a prolonged period of economic decline if the government does not act now.

Continued economic stagnation would undermine prospects for future growth and be "really damaging in the long run," warned economist William D. Nordhaus. Since businesses are not investing enough in new goods, he said, there'll be fewer resources in the future to spur growth. This could translate into a cycle of less production, less research and development, and the "atrophying of jobs skills" of the long-term unemployed, he said.

The economy needs "the jobs bill times three," said Nordhaus, and perhaps even a large enough stimulus to rival government spending during World War II, which lifted the U.S. economy out of the Great Depression.

He added that in the long run, the U.S. needs to pay for the stimulus "in ways that reduce inequality." He recommended implementing a carbon tax and letting the Bush tax cuts expire as ways to pay for that stimulus, which would help the U.S. become a "livable" place for the 99 percent of people who have become "disenfranchised from making decisions" that could improve their well-being.

The central problem weighing on the economy is a lack of business and consumer confidence, stemming from alarm about the gridlock in Congress and the European sovereign debt crisis, Shiller said. "We have a sense of inability to solve problems," he added.

The decline in unemployment that would result from a fiscal stimulus could boost confidence, said Shiller, and create a "strong" self-reinforcing cycle of more spending and hiring.

Economist Richard C. Levin, who is also president of Yale University, suggested that since Congress hasn't been able to take action to combat unemployment, a standby independent commission, similar to the Federal Reserve, should be created to make some fiscal policy decisions when the unemployment rate reaches a certain level. He said that during that 5 percent of the time when the Federal Reserve lacks the tools necessary to improve the economy, an independent commission probably would be a more effective arbiter of fiscal policy than Congress.

"You have to put a very large fraction of the blame on Congress for not acting," Levin told The Huffington Post before the panel discussion.

Some of the economists said that if economic growth does not improve, the Occupy Wall Street protests could transform into social unrest on a scale similar to that of the 1960s and 1970s.

Geanakoplos argued that mortgage service companies need to start forgiving some portions of loan principal before 8 million more people are thrown out of their homes, and "that's when the riots are going to start." He said local bankers should be writing down debt so that lenders can make as much money as possible from underwater home loans, since defaults are ultimately not the best solution for either homeowners or lenders.

If mortgage principals are not written down, Geanakoplos said, the next best solution might be to boost inflation by a certain amount over the next few years, possibly as much as a 20 percent increase in prices, in order to inflate away people's debt.

"I'm not sure this idea is that good," Geanakoplos acknowledged, "but it's a radical idea that we haven't really considered seriously."

He added that the Federal Reserve should focus on eliminating debt rather than encouraging borrowing with lower interest rates, since debt is the central issue preventing renewed spending. "The heart of the problem is people borrowed too much with too little collateral," he said.

In the meantime, allowing the Bush tax cuts to expire in order to raise government revenue probably would not place much stress on higher-income people, said economist Judith Chevalier. She explained that the "upward march" in incomes for the well-off has not been sensitive to changes in the tax rate over the past few decades.

But she cautioned that an inordinate focus on the wealth of the top 1 percent, including populist demands for pay limits on chief executives, probably would not help the other 99 percent.

If CEO pay was cut, profits might rise, said Chevalier, "but that doesn't really have a logical connection to raising pay for everybody else or creating jobs for everybody else."

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