PHOENIX, Ariz. -- A member of the President Obama’s Council of Economic Advisers as the mortgage-led global credit crisis erupted says that the last big weapon in the Federal Reserve Board’s arsenal to create strong growth is to avoid “tinkering around the edges” of the economy and aggressively reset expectations.
The Federal Reserve should set a “nominal target” for growth in the nation’s gross domestic product that is well above its current low rate for coming out of a recession, said Christina Romer, now an economics professor at the University Of California, Berkeley.
“One thing I think it would do is pack a really big expectations wallop,’’ said Romer, speaking at the Super Bowl of Indexing wealth management conference here. “A new operating strategy is something that could really break through and affect people’s behavior.”
Such a “new operating strategy” is needed to get the economy on the kind of course normally seen after a recession. In the first nine quarters after the 1982 version, the economy grew at an annual rate of 6.3%. In the first nine quarters of this edition, the rate has been 2.4%, barely at the nation’s historical rate of growth.
And if a new approach is not taken, it could be decades before the nation is back at full employment.
Friday’s announcement that 120,000 jobs were added to the nation’s payrolls masks the fact that that barely covers the normal needs of the U.S. economy. Natural growth in the work force means that the nation needs to add 100,000 jobs a month, just to keep employment even.
If the nation only adds 20,000 jobs above the maintenance level of employment, it “will take 40 years to undo the damage inflicted by the recession,’’ the former chair of the Council of Economic Advisors said.
Romer did not say what target she would set for growth in the gross domestic product, if she were in the shoes of Fed chairman Ben Bernanke.
But setting a target would go a long way toward ending internal squabbling over what next steps to take and instead galvanize to enact a series of steps, from bond purchase to other measures, that would lead to the target set.
At 8.6%, she said the nation’s unemployment rate is “still painful” and just 1.1% below its peak during the crisis.
Underlying a Fed-set target for GDP growth, the answer to the nation’s economic ills, she said, is creating demand for the nation’s output.
Which, in circular fashion, comes back to putting more people back to work. To buy goods and services.
Holding demand back is overindebted consumers, still recovering from taking on mortgages too big for their budgets. That leaves home vacancy rates at almost twice the normal level, she said.
And since housing purchases and the related construction of new homes, purchases of big appliances and the like are big factors in prior recoveries, a key source of demand if missing.
The nation’s exports also were expanding until about a year ago, she said. But much of that was coming from key trading partners: countries in Europe. And now, given that continent’s sovereign debt crises, that source of demand is also largely gone.
That double-whammy of consumer and business pullbacks in demand is what sets the stage for setting a growth target and finding ways to get back to full employment much faster.
“Everything else I am afraid is just going to be tinkering around the edges,’’ she said.
The setting of a growth target by the Fed would be similar to the Volcker Moment, she said, when former Fed chairman Paul Volcker set monetary policy targets roughly 30 years ago to break the back of the nation’s double-digit inflation rates.
The setting of a nominal target would not be a “sneaky way to increase inflation expectations,’’ as she says prize-winning economist Paul Krugman contends, but instead lead to specific actions. One example: Another round of “quantitative easing” by the Fed, where it buys up higher-rate long-term Treasury bonds to make it easier for companies to plan on low rates on long-term loans they seek.
She also said the nation needs to reform bankruptcy laws and seek other measures that would clear out the stagnant stock of homes that have either been vacated or for which loan modifications still need pursuit. She said there remains “$750 billion of negative equity” in homes, nationwide.
Finally, she said “fiscal stimulus absolutely does work” and that the Obama Administration should pursue another round of stimulus that includes infrastructure spending that has long-lasting benefits for the economy.
Also high on her list: tax cuts for employers that raise payrolls. Current policies embedded in the Obama Administration’s American Jobs Act should be extended to large employers. There should not be distinctions made between what size of company qualifies for the cuts.
Congress should not postpone, however, plans for deficit cuts. Instead, that has to be part of the new “operating strategy.’’
Both parties have to rally around a “grand bargain” like the plan proposed by a deficit reduction commission led by former White House chief of staff Erskine Bowles and former Republican Senator Alan Simpson of Wyoming. The Bolles-Simpson plan that called for $4 trillion in revenue hikes and spending cuts over the next two decades. That’s twice the rate targeted in recent Congressional debates, Romer said.
In effect, the Romer plan calls for stimulus to demand now, so a bigger work force can purchase more goods and services – and pay more taxes. And deficit cuts that are backloaded, so that deficits do not reach unsustainable levels.
Right now, long-term deficit forecasts are running at 16% of gross domestic product, she said. And that can’t be sustained, without rendering the nation insolvent.
The “expectations wallop” that an official GDP target from the Fed would set would deliver a “major jolt” to consumer and investor confidence.
And start the nation on a road to real recovery, she contended.
-- This article first appeared on Securities Technology Monitor.