Good economic news came for liberals at just the right moment. As the mid-September polls showed Donald Trump closing the gap with Hillary Clinton, the Census Bureau reported that 2015 was the best year for middle-income households since it started keeping the records in 1967. Their incomes rose more than 5 percent. Poverty declined.
Democrats took the numbers as a vindication of the Obama administration’s policy record: President Obama had rescued an economy in free fall, and done it without Republican help. Almost all Republicans in Congress voted against stimulus legislation in February 2009. Republicans have often said that various Obama policies, from his health-care law to his tax increases to his environmental regulations, would mean economic ruin. The new numbers, according to Democrats, disproved those claims. Instead, they argued, the economy is doing pretty well and would be doing even better if Republicans would quit obstructing the administration’s agenda.
The Census Bureau findings did not, however, give Republicans any pause. By a variety of measures, especially that of GDP growth, this is the weakest recovery on record in our country’s history. The Census report itself showed that middle-income households were still worse off than before the economic crisis. Liberals attribute the sluggish pace of the recovery to the aftermath of a financial crisis, conservatives to liberal policies. Republicans note further that labor-force-participation rates are low, even for able-bodied young men. And growth rates, already low, have been falling for three years.
Republicans often add that the economy would be doing even worse if the Federal Reserve were not artificially boosting it. Trump has said that Janet Yellen, the top Fed official, is keeping interest rates low to help the Democrats and should be “ashamed” of herself. “We have a very false economy,” he said. Trump did not always hold this view. In two interviews in May, he said that interest rates should stay low and that raising them “would be a disaster.” Back then, he also said that he had “great respect” for Yellen.
On this question, Trump has moved toward Republican orthodoxy while supplementing it with his own trademark personal shots. During the early years of the Obama administration, many Republican politicians warned that monetary policy was too accommodative and that inflation was sure to result. But the last six years have seen less inflation than any period since the early 1960s. By the time of the latest presidential primaries, most Republicans had stopped talking about inflation. Still, most of the Republican presidential candidates found other reasons to criticize the Fed for trying too hard to stimulate the economy. They said that the Fed’s activism had kept wages down, increased inequality, punished savers — and, somewhat paradoxically, helped President Obama.
That the Fed’s policy has helped Obama and, now, Clinton is the most defensible part of this Republican orthodoxy. It has helped the Democrats by helping the economy. But the nature of that economic help is easily misunderstood. Interest rates have been low around the globe in recent years, not just in the United States, and most estimates of the “natural” or “equilibrium” interest rate have been low as well — suggesting that Fed policy is not the main reason for low observed interest rates. There is good reason to think that if the Fed raised interest rates above their natural rate, the effect on the economy would be contractionary, which would not be good for savers or wage-earners. The European Central Bank raised interest rates in a sluggish economy in 2011. The result was a renewed European recession.
The Fed hasn’t “artificially” helped the economy so much as it has refrained from the kind of self-destructive policy followed by the ECB. If anything, the Fed has erred on the side of contractionary policy. It spent much of 2015 promising to raise interest rates soon, and did at the end of the year, even though inflation was at the time, and remains, below the Fed’s stated target of 2 percent annually. Growth, as noted earlier, has slowed. Trump was right about interest rates in May, not in September.
If the Fed hasn’t been giving the economy a years-long sugar high, though, it calls into question whether the rest of Obama’s economic agenda has been quite as destructive as conservatives often say. And there is good reason for thinking that they have overstated its impact.
In particular, Obama’s tax increases have been relatively mild. The Obamacare legislation included a 3.8 percent tax on investment income. Another tax increase happened as a result of the expiration, at the end of 2012, of the tax cuts enacted under George W. Bush. Obama refused to renew those that affected the highest earners. Married couples making more than $450,000 a year, and singles making more than $400,000, saw their tax rates rise from 35 to 39.6 percent. Taxes on capital gains and dividends went from 15 to 23.8 percent.
It is certainly possible that these tax increases weakened the economy by reducing the incentive to work, save, and invest. But any such supply-side effect is bound to have been small. The Tax Foundation, which uses an economic model that incorporates supply-side assumptions, recently found that the Bush-era reductions in income-tax rates had over the long run enlarged the economy by 2.3 percent. And remember, some of those reductions have stayed in place. Taxes on dividends remain lower than when Bush took office. The capital-gains rate is only 3.8 percentage points higher than it was at the end of the 1990s boom.
The economy grew faster in 2013 and 2014, when all the Obama-era tax increases were in effect, than in the previous two years. Perhaps the economy would have accelerated even more without the tax increases; but other factors were capable of overcoming any negative effect they had.
Other Obama policies may also have had negative effects. The Congressional Budget Office estimates, for example, that Obamacare will reduce hours worked by the equivalent of 2.5 million jobs. Its analysis of the issue stresses that the law’s subsidies decline as people gain higher incomes, and therefore reduce their incentive to make additional income. The higher minimum wage that took effect in Obama’s first year in office may have suppressed job growth; extended unemployment insurance may have reduced employment as well.
On the other hand, the case that Obama’s policies turned the economy around is also weak. The models and studies suggesting that the stimulus bill worked almost all ignore the role of monetary policy. But if Congress had not passed a stimulus bill, surely the Fed would have engaged in more quantitative easing in 2009, or taken other expansionary steps (such as stopping the payment of interest on banks’ excess reserves). We overestimate the effects of fiscal policy if we fail to account for the possibility of such “monetary offset.” Some Keynesians predicted that the deficit-reduction measures that took effect in early 2013 would hurt the economy. But the Fed had at the same time adopted a more expansionary policy, and in fact economic growth accelerated during the period.
Confusion about economic policy, often involving the Federal Reserve, is thus distorting both parties’ analyses. Conservatives, convinced that monetary policy is dangerously loose, are looking hither and yon for evidence that it is causing problems. (When all else fails, try “asset bubbles.”) Liberals are telling themselves that the Fed has proven that it cannot hit its 2 percent inflation target, and so we need fiscal policy to play a bigger role in stimulating the economy in the future. But the Fed raised interest rates last year when we were below that target, suggesting that higher inflation was something it didn’t really wish to pursue. Whether or not it was right to take that course, there is no reason to suppose it has reached the limit of its power.
If the political debate over the economy is unsatisfying, so is the economy itself. How unsatisfying? Democrats and Republicans are offering voters different answers to that question. Some econometricians have developed models that relate recent economic variables to election outcomes. Yale economics professor Ray Fair devised the most prominent of these models. Based on how the economy has been performing, his equation predicts a Republican blowout.