Yellen to Washington D.C.: Fiscal Austerity Slows Recovery

Last Monday, Federal Reserve Vice-Chair Janet Yellen gave the keynote speech at an AFL-CIO economic policy conference on restoring shared prosperity.

Dr. Yellen began by noting that the Federal Reserve “is the only agency assigned the job of pursuing maximum employment.” She then went on to acknowledge “the gulf between maximum employment and the very difficult conditions workers face today.” That gulf is the reason behind the Federal Reserve’s on-going actions to strengthen the recovery and why there is continued need for “forceful action to increase the pace of economic growth and job creation”.

Dr. Yellen described the recession as the deepest recession since World War II, and she noted that the recovery “has been significantly weaker than past experience would have predicted.”

These important statements show a Federal Reserve that is focused on the critical task of creating jobs, ending mass unemployment and restoring healthy economic growth. The Federal Reserve has a so-called “dual mandate” to promote price stability with maximum employment. That is the law, passed by Congress and signed into law over thirty years ago. The Federal Reserve has often in the past been less focused on its maximum employment obligation.

Why has the recovery been weaker than expected? According to Yellen, the economy has lacked some of the usual tailwinds and has faced unusual headwinds. Here the story gets interesting. Yellen said:

“….Discretionary fiscal policy hasn’t been much of a tailwind during this recovery. In the year following the end of the recession, discretionary fiscal policy at the federal, state, and local levels boosted growth at roughly the same pace as in past recoveries, as exhibit 3 indicates. But instead of contributing to growth thereafter, discretionary fiscal policy this time has actually acted to restrain the recovery. State and local governments were cutting spending and, in some cases, raising taxes for much of this period to deal with revenue shortfalls. At the federal level, policymakers have reduced purchases of goods and services, allowed stimulus-related spending to decline, and have put in place further policy actions to reduce deficits.”

The lesson is clear. In the past, Congress took action to deliver sustained stimulus policy that helped lift the economy out of recession, thereby also helping close the budget deficit caused by recession. But not this time. Instead, Congressional Republicans have persistently blocked needed fiscal stimulus and they have compounded the injury by pushing for fiscal austerity which cuts spending. That’s the opposite of what was and still is needed. In effect, what should have been a tailwind has been transformed into a headwind.

The evidence is clear. Using Fiscal policy to revive the economy and create jobs has worked in the past and, in the past, Republicans supported fiscal stimulus to help Presidents Reagan and George W. Bush. Today, we need government action to invest in our country and create jobs, not sequester cuts that strangle our economy and destroy jobs.

This article was originally posted on AFL-CIO NOW on Tuesday 12, February, 2013.

By Thomas I. Palley, Senior Economic Policy Adviser, AFL-CIO

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