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If you think George W. Bush’s economic policies caused the Great Recession and Barack Obama’s ended it, then your Election Day decision is likely an easy one. But placing politics aside, I don’t think the economic evidence supports that thesis. I’ve stated my reasons, in bits and pieces, across several blog posts. Maybe now would be a good time for a unified, though brief, rebuttal.
Let’s take the two strands of the argument and examine each. First, did Bushonomics cause the worst economic downturn and financial crisis since the Great Depression? To make that case, you need to specify a policy causality (or two or three) and a transmission channel. But when you go down the list of usual suspects, none of them pans out:
— It was the Bush tax cuts. Except lowering taxes increases demand and improves supply-side incentives. The only way this theory might be true is if bond markets feared tax cuts would be inflationary or would hurt the ability of the US to pay back its debts. But interest stayed low during the 2000s. Also note that Obama says he wants to again extend most of these cuts.
— It was Bush’s income inequality. Except that a 2012 study, Does Inequality Lead to a Financial Crisis by economists Michael Bordo and Christopher Meissner, seems to dismiss that linkage. Using data from a panel of 14 countries for over 120 years, they found “strong evidence linking credit booms to banking crises, but no evidence that rising income concentration was a significant determinant of credit booms. Narrative evidence on the US experience in the 1920s, and that of other countries in more recent decades, casts further doubt on the role of rising inequality.”
— It was the Bush budget deficits. Except both inflation and interest rates were low during the 2000s. This is really another version of the tax cut argument, but adds in deficits from Medicare expansion and the wars in Iraq and Afghanistan. Besides, annual budget deficits averaged just $220 billion from 2001-2007. During the 2010-2012 recovery, they’ve averaged roughly $1.3 trillion. So deficits caused the Great Recession even though they are six times higher now?
— It was Bush’s financial deregulation. Except the law that ended Glass-Steagall was signed by President Bill Clinton. And few analysts think the end of Glass-Steagall directly contributed to the financial crisis. Another candidate was a 2004 rule change by the Securities and Exchange Commission that supposedly allowed broker dealers to greatly increase their leverage, contributing to the ﬁnancial crisis. But as Prof. Andrew Lo of MIT explains in a 2011 paper, ”… it turns out that the 2004 SEC amendment to Rule 15c3–1 did nothing to change the leverage restrictions of these ﬁnancial institutions.”
So what did cause the Great Recession? Politicians love to blame big downturns on “market failures.” Doing so then allows them to expand government and their own power. That’s what happened during the Great Depression. But it wasn’t the free market that failed back then, it was the Federal Reserve.
And the same goes for the Great Recession. In The Great Recession: Market Failure or Policy Failure, Robert Hetzel, a senior economist at the Richmond Fed, pins the blame squarely on the US central bank. The downturn first started with “correction of an excess in the housing stock and a sharp increase in energy prices” — the housing bust and the oil shock. Those two things were enough, in Hetzel’s view, to cause a “moderate recession” beginning in December 2007.
But it was the Fed’s monetary policy miscues after the downturn began that turned a run-of-the-mill recession into a once-in-a-century disaster. Not only did the Fed leave rates alone between April 2008 and October 2008 as the economy deteriorated, but the FOMC “effectively tightened monetary policy in June by pushing up the expected path of the federal funds rate through the hawkish statements of its members.
In May 2008, federal funds futures had been predicting the rate to remain at 2% through November. By mid-June, that forecast had risen to 2.5%. As Hetzel writes in a Fed paper that inspired the book, “Restrictive monetary policy rather than the deleveraging in financial markets that had begun in August 2007 offers a more direct explanation of the intensification of the recession that began in the summer of 2008. Irony abounds.’
And what ended the Great Recession? Was it the $800 billion Obama stimulus? As I have often pointed out, White House economists thought the stimulus would help lead to roughly 5% unemployment and 4% GDP growth in 2012.
Instead, the US economy is growing at half that pace and unemployment is sharply higher — even before you account for the massive drop in labor force participation.
But what do left-of-center or pro-Obama economists say? Here are Alan Blinder and Mark Zandi in a 2010 paper:
In this paper, we use the Moody’s Analytics model of the U.S. economy—adjusted to accommodate some recent financial-market policies—to simulate the macroeconomic effects of the government’s total policy response. We find that its effects on real GDP, jobs, and inflation are huge, and probably averted what could have been called Great Depression 2.0.
For example, we estimate that, without the government’s response, GDP in 2010 would be about 11.5% lower, payroll employment would be less by some 8½ million jobs, and the nation would now be experiencing deflation.
When we divide these effects into two components—one attributable to the fiscal stimulus and the other attributable to financial-market policies such as the TARP, the bank stress tests and the Fed’s quantitative easing—we estimate that the latter was substantially more powerful than the former.
So Blinder and Zandi credit the Fed and TARP, Bernanke and Bush, mostly for breaking the back of the downturn. Indeed, the steepest drops in GDP ended before Obama took office and before the stimulus kicked into gear. And eventually, of course, the economy would recover on its own as long as government didn’t interfere with anti-growth policies such as tax hikes or massive new regulations.
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