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Mark Thoma worries about gridlock in the house as a result of the upcoming elections. He has three big concerns that he’s looking at in the short-run that could prove to stall recovery. I want to address what I believe about all three.
The first is that we will be gripped by the austerity movement that has captured Europe and that, as a result, we will withdraw stimulus too soon. Republicans have been promoting policies to reduce the deficit for some time now, spending cuts in particular are on the agenda. Many among the Republican leadership would have canceled the remaining stimulus already, including extensions to unemployment insurance, if they were in control.
Now, according to Nate Silver (@fivethirtyeight), Republicans have a fairly good shot of gaining 52 seats in the House, for a house composition of 231R-204D. This may be enough to stall any new spending, based on the populist rhetoric of the tea-party base…but I don’t think it is enough to move any actual significant budgetary legislation. One reason is that Republicans don’t actually care about budget deficits. Further, the austerity plans that are being implemented in Europe aren’t exactly the most immediate. I don’t think that austerity in Europe is going to cripple any economies, much less their own. The Bank of England in particular has intimated that it would likely offset any contractionary impact of Britain’s budgetary plans. So the question is still very much up in the air as to whether austerity is the death knell for recovery — I, personally, don’t think it is; but that is contingent upon a willing central bank.*
The second concern is related to the first. I expect that we will have a slow, agonizing recovery, particularly for employment. I do not expect a double dip, but it’s not out of the question by any means, and we need to be ready in case it happens. Unfortunately, the election is likely to bring gridlock and it’s doubtful that Congress will be able to act in response to a second downturn. An increase government expenditures in response to a slowdown is certainly off the table. It’s hard to imagine Republicans who have argued — wrongly in my view — that the stimulus did not help the economy getting behind increased spending.
According to recent movements in the markets, there is actually reason to be optimistic. Even so, employment may not come down to traditional “full employment” levels (a situation that I find highly likely). However, after (or if?) we return to the previous trend rate of NGDP**, those are probably more issues of structure (search/match, skill profiles, etc.) that the government may be able to help mitigate, but will likely to be alleviated slowly, simply by the nature of these problems. What does robust growth and stagnating employment look like for the future of economic policy? Protectionism, which highly en vogue among tea partiers and the “labor-left” alike. That is something that I’m worried about.
But my biggest concern is what will happen if new problems emerge in the financial sector. The resolution authority in the Dodd-Frank legislation is supposed to prevent the need for another financial bailout, but I am not at all confident that this will be sufficient to solve widespread problems and threats of failure in the banking system. There’s a good chance that the resolution authority won’t get the job done and that a bailout will be the only way to resolve severe problems. However, if problems do arise and another financial bailout is needed, forget it. Opposition to the banking bailout makes it nearly impossible for Congress to undertake another bailout of the financial system.
This is a problem where Thoma and I seem to disagree about causality. Would the Fed allow NGDP to fall at the fastest rate since 1938 once again, as they did in late 2008? It’s possible, but I don’t think it is likely…and as you may know, I think it was increasingly tight money which led to big financial problems — not the other way around, which I believe is the causality that Thoma is looking at.
Why don’t I welcome gridlock in economic policy that is almost certain in our future? Well, because there are important questions about the response to the recession that need to be answered, that will most likely remain for the foreseeable future under gridlock. The structure of bailouts, the role of Fannie/Freddy in the future of housing policy (and the future of housing policy in general), the supposed “world trade imbalances”, the future health care policy, and to a lesser extent UI, minimum wage and the very structure of taxes in the US. These are all very important questions that affect millions of people, and are very hard to answer under a regime of unanimous opposition that would likely prevail under a gridlocked government.
However, I don’t think the recovery will be endangered by gridlocked government, since the Fed has signaled it intends to take the lead…something it should have done two years ago.
P.S. Should probably note that the Yglesias link above disagrees with the notion that things cannot get done under divided government.
*Ability isn’t really a question in my mind.