The fiscal policy response to the crisis has been disappointing. Monetary policy loses its effectiveness in a recession. There are some things monetary policy can do -- important things such as injecting liquidity into fearful, frozen financial markets to prevent a complete meltdown of the system. But when it comes to providing a big shock to aggregate demand sufficient to turn the economy around and propel it back toward full employment, monetary policy alone isn't enough. It's true that monetary policy can lower real interest rates -- even at the zero bound for the federal funds rate, it's still possible to use quantitative easing to nudge long-term interest rates downward -- the problem is that all this does is create an incentive for more investment and consumption (mainly of durables), there is nothing to guarantee that people will actually respond. My reading of the evidence is that to the extent that households and businesses do respond to lower real interest rates during a recession by consuming or investing more, the response is not very strong.
Because monetary policy loses effectiveness in a deep recession -- something I've been teaching for decades -- I was among the first to call for aggressive fiscal policy. Fiscal policy creates demand directly, it does not rely upon incentives and the hope that people will respond to them. When the crisis hit, we needed fiscal policy right away. Given the lags between changes in policy and actual effects on the economy, which were known to be lengthy, and given that monetary policy was not going to be enough, there was no time to "wait and see" (as many people I respect were calling for). But the reality is that fiscal policy didn't get put into place until much, much later, far too late to stop the worst of the downturn (and it wasn't big enough anyway). The way too slow policy process, and the way too small policy that came out of it, was frustrating to watch.
I think we'd be much better off today if we'd done what is necessary right away instead of hoping and hoping that things weren't going to be so bad, and that we could escape the need for an aggressive policy intervention. This crisis has taught me that policy of that magnitude is nearly impossible to put in place based upon what looks to be happening, i.e. before the recession actually occurs. There must be clear evidence that a severe recession is actually underway before policy will be considered. Unfortunately, by that time it's too late to prevent the worst part of the downturn.
Now that we are hitting the other side, I'm feeling frustrated again with the lack of action from policymakers. I expect the recovery to proceed at a snail's pace, labor markets in particular. If employment rebounds quickly, great, but that's not what I think is going to happen, and that's not what the evidence suggests. If the recovery is going to be slow, then it's not too late to provide more help. Instead of getting back to full employment by, say, 2013, we could get there sooner if we act now. I'm not the greatest artist in the world, but I even drew a picture:
Why settle for the blue line recovery when the green line is possible? Frustration over the fact that we seem to be headed on the blue-line trajectory explains why I've been reluctant to highlight what little good news there has been about labor markets recently. I don't want to jump on the "things are getting better" bandwagon when there is still more that policymakers can do to help, and when there are still considerable uncertainties about the strength of the budding recovery.
But, as I said at the beginning, even though it's not too late for more help to make a difference, it's not going to happen. Now that the recovery seems to have started and the budding optimism is apparent, we will turn our attention elsewhere, to financial reform, to global warming, and to other issues. We'll forget about all the people who could have been working, but instead have to hope Congress doesn't cut off their unemployment insurance before they can find a job.
I'll still complain -- there's no reason to let policymakers off the hook -- but it's time to give up the hope that anything more will be done to help the unemployed find jobs.