NEW YORK – In September 2008, the global economy and financial system was hit by an earthquake, whose epicenter was in the United States. It was the end of the Bush administration. The presidential election was two months away. The timing, from the point of view of crisis management, could not have been worse.
The level of uncertainty about asset values, solvency, and the connectedness of balance sheets that prevailed at the time was extraordinarily high. Uncertainty bred fear, causing banks, businesses, and households to hoard cash. Consumption plummeted, taking down retail sales with it, and, after a short lag, employment and investment as well. Individually rational choices were giving rise to collectively irrational results.
These conditions had all the makings of a depression scenario, with credit rationing destroying businesses indiscriminately, and thus required fast, aggressive, and unconventional action by the US government and the Federal Reserve.
The response, mounted by the Bush administration and taken over by the Obama administration, was all of the above. A combination of financial-sector recapitalization and rapid expansion of the Fed’s balance sheet prevented a complete credit lockup.
Policies sometimes missed their target and had to be modified. For example, the Troubled Asset Relief Program (TARP) originally targeted the purchase of complex securitized assets that had lost value and stopped trading, but had to be partly altered to direct infusions of capital into banks.
Financial support for Wall Street villains infuriated many, but no one proposed a better alternative at the time – or has since. The Bush and Obama administrations both understood that wise policymaking in crisis circumstances requires selecting the least bad option, accepting the inevitable anger and criticism, and implementing the decision quickly. The first priority, after all, was to stabilize a highly dangerous situation.
The Obama administration then assumed responsibility for organizing the government’s efforts to boost recovery, the centerpiece being a large stimulus package to shore up the real economy. Following the capital injections and Fed programs aimed at supporting the financial system, the stimulus package was an important step, notwithstanding disagreements about its size, effectiveness, and targeting.
After its enactment in late February 2009, the markets’ downward plunge began to decelerate, and prices stabilized the following month.
The Obama administration was not responsible for poor US economic performance in the immediate post-crisis period; that was inevitable. But it was responsible for allowing flawed expectations of a sharp recovery to pre-crisis levels of output and consumption to persist. And that left the administration open to the charge that bad policy was the cause of poor economic performance.
The administration needed to see – and to say – that the debt-fueled pre-crisis economy was on a dangerously unsustainable path, and that the challenge now, having averted a depression, was to make a difficult transition to a new path. Instead, it treated the Great Recession as similar to others in the recent past, albeit deeper.
Perhaps that outcome was foreordained. Shortly after taking office, the administration faced a crucial strategic decision about the scope and breadth of its agenda. One option was to defer important policy initiatives (in health care, energy, and the environment, including climate change) and focus political capital and fiscal resources on restoring growth and employment.
The alternative was to pursue a full policy agenda aligned with the priorities and commitments enunciated in Obama’s election campaign.
The narrower agenda – financial reform, stabilizing the housing market, restoring balance sheets, addressing structural deficiencies, and restoring growth and employment – would not have captured the public’s imagination, and almost certainly would have disappointed Obama’s enthusiastic supporters.
But, if adopted, it would have had the advantage of clarity and focus, in an area of central importance to everyone. And, if successful over time, it might have made the rest of Obama’s agenda seem less overwhelming and more affordable.
Obama chose the second more expansive option, which generated more or less the opposite dynamic: benefits became risks. The full agenda would have been much easier to implement successfully if the assumptions about the nature of the recession and the likely path of recovery had been accurate. But they weren’t.
And now, as the administration shifts to a more central focus on restoring growth and employment, it risks getting bogged down as declining economic performance relative to expectations translates into waning political support.
The administration is not entirely to blame, of course. It has had to deal with a widespread and understandable loss of confidence in elites – academics, policy analysts, Wall Street, business leaders, regulators, and politicians – which makes implementing pragmatic, centrist policies more difficult.
This phenomenon precedes the crisis, but the crisis has certainly made it worse. Elites, after all, failed to see the crisis coming and to take steps to prevent it, and some of them appear to be the only ones who are recovering: profits are up, but employment is not.
Moreover, many Americans’ anxiety is rooted in deepening income inequality. The economic and political implications of this long-term trend have been widely discussed but left largely unattended, betraying the general lack of concern for distributional issues that shadows elites’ excessive faith in markets to provide beneficial outcomes.
Indeed, a lack of clarity about means and ends spans American politics. Markets, regulatory frameworks, and public-sector investments are means to attain shared goals. The administration, political and policy elites, and private-sector leaders need to state clearly that the main goal of domestic economic policy and strategy is to reestablish a pattern of inclusive growth and employment.
The choices to be made are not simple, obvious, or clear-cut. Persistence, pragmatism, and some willingness to experiment will help. But Obama needs to take the lead in redirecting a highly polarized political environment engaged in a debate about the appropriate role and size of government toward a more pragmatic, results-oriented agenda.
Michael Spence is Professor of Economics, Stern School of Business, New York University, and Senior Fellow, the Hoover Institution, Stanford University.