Why Is the Economy Stuck in Slow?

by J. D. Foster

The Great Global Recession technically ended in June 2009. Two years later, the reported unemployment rate (9.1 percent) is again rising and would be higher yet if millions of workers had not left the workforce. Job growth has nearly stalled. The economy remains stuck in slow motion, and may even be slowing.

The American economy has enormous strengths — flexible markets and a tradition of labor mobility, a smart workforce, a strong entrepreneurial class — that should be driving the recovery and steadily lowering the unemployment rate. What is holding back the natural healing powers of the great American jobs machine?

Confidence, or a lack thereof.

A recovery’s strength is normally dictated by two factors. The first is the cause and depth of the recession itself. Traditional recessions driven by monetary corrections — fighting inflation — are typically brief, painful affairs that give way to robust recoveries. Economies take longer to reset from recessions triggered by asset-price corrections (housing) and financial market chaos (the global financial contagion of 2008–2009). Markets must find and trust in new asset-price levels before resuming normal buying and selling. Financial institutions must repair their balance sheets before resuming normal lending and investing. This all takes time.

The recession’s depth also matters. Recessions are the unfortunate by-product of correcting past mistakes — misguided investments, excessive inflation, etc. — and are highly destructive as the consequences of correction spread far and wide. The deeper the recession, the more collateral damage is inflicted on tangentially related businesses, families, and investment plans. How deep was the last recession? It is not called “Great” because it was popular.

The second factor dictating a recovery’s strength is government policy. Politicians naturally try everything they can think of to soften a recession’s blow. Unfortunately, almost everything government does in response to a recession delays and weakens recovery. This was true of the first-time homebuyer’s credit as well as the various programs to slow the foreclosure process or otherwise try to keep families in homes they could not afford. Well-intended, these efforts only delayed the recovery further by delaying the price-discovery process — what are these homes really worth? Two years into the recovery, housing prices nationally are still falling.

The Obama fiscal stimulus was another failure. It was based on the flawed theory that government could increase demand in the economy by reshuffling demand, taking a dollar out, putting it back in, and pretending the economy had gained a dollar. Naturally, this approach failed. Worse, it substituted for other fiscal policies that would have helped. While politically unpalatable to the president and his party, permanent tax-rate reductions do help even in the depths of recession. Incredibly, the president campaigned on and continues to argue for higher tax rates.

The Obama stimulus also failed because it added to already-bloated budget deficits, thus increasing fear about the nation’s debt. However much or little the American people understand about macroeconomics or budgets, they understand that too much debt is dangerous. Fear of soaring national debt is palpable, and debilitating to recovery.

Americans also understand that higher taxes would weaken the economy. Yet they see the president renew his politically motivated, ideologically grounded call for higher taxes on upper-income individuals, on saving, and on small businesses. Even those who agree with this policy politically must acknowledge it makes no sense in a time of high unemployment. Once again, Obama is demonstrating to the American people that his ideology is more important than their jobs and economic security.

Then there’s Obamacare, the Dodd-Frank financial-regulation bill, the multitude of costly and anti-growth regulations bubbling out of the bureaucracy, and an energy policy that is the epitome of incoherence. And don’t forget the international dimension: The administration has put free trade in the freezer. No wonder the business community firmly believes the administration is anti-business. No wonder job creation is anemic.

The missing ingredient in this recovery is confidence. #more#Americans are, by nature, an optimistic lot. Our typical attitude is that today’s clouds will give way to tomorrow’s sunshine. But that’s not how we’re behaving economically at the moment.

Expectations play a crucial role in the economy. For example, expectations about inflation influence interest rates, naturally, but they also influence decisions about work and wages. Expect higher inflation and you’re going to demand higher wages.

Expectations about the future of the economy play a similarly central role in how the economy performs. When they believe renewed prosperity is just around the corner — perhaps not today, but soon — businesses shift their perspective. They plan for expansion and act on those plans with increased investment even though the demand is not yet there. Entrepreneurs actively pursue opportunities that are too risky when the economy is moribund but that promise success in a better environment just over the horizon. Sharing this renewed hope, families likewise move out of hunker-down mode, re-entering the labor force or pursuing new job opportunities, or even starting their own businesses.

An economy is more than bricks and mortar, goods and services, labor and capital. It is also people acting in their own best interests guided by their expectations of what could be. Hope, confidence, expectations, whatever the label — it is a key factor often left out of the economics textbooks. But hope builds a bridge of positive actions from a weak recovery to a strong recovery. In purely economic terms, confidence arbitrages belief in a strong economy in the future and pulls some of that strength into the present, helping to make prosperity a self-fulfilling prophecy.

Presented with abundant evidence, the American people have rightly judged Obama economic policies failures, and they recognize he intends to continue those policies. Thus, they expect the economy to continue to muddle along, at best. Those are likely to be self-fulfilling expectations unless and until there is real change in Washington.

J. D. Foster is Norman B. Ture senior fellow in the economics of fiscal policy at the Heritage Foundation.