Through both the recession and the present lethargic recovery, progressive commentators have blamed slow job creation on insufficient aggregate demand. Progressives like Paul Krugman, Brad DeLong and, recently, Laura Tyson, argue that while Americans stand ready and waiting to work and the government has shoveled billions into the economy, tepid demand from recession-weary consumers has kept businesses from investing. The data, however, tell a more complex story-and caution against yet more stimulus.
Although demand’s recovery from the recent recession has been slower than normal, many relevant indicators are approaching, or have exceeded, pre-recession levels. Real personal consumption expenditures rose 2.4 percent in the third quarter of 2010 and 2.2 percent in the second-faster than the average growth rate in 2007 and about as fast as in 2006. Moreover, fourth quarter growth clocked in at 4.4 percent, a level unseen since 2004.
Other measures of demand are also up: retail and food service sales have surged from their recession-era lows and are now only 3 percent off their pre-recession level and 4.2 percent lower than their all-time, mid-’06 high. Inventory-to-sales ratios, which spiked markedly as shoppers hunkered down during the recession and left businesses to quietly build up inventories, have also seen record lows in recent months.
All the while, the personal saving rate, which last year reached levels unseen since the mid-1980s-about 8.2 percent-has begun to taper off. Although nowhere near the shocking lows that marked the mid-00s, savings has slowly edged down to 5.3 percent. Not only does this indicate consumers are spending their disposable income more than at the height of the crisis, but it reflects a stable, pro-growth savings level. After all, it was a 4-6 percent savings rate that characterized the longest period of economic expansion in American history: the 1990s. And though some may fear that Americans might once again be financing reckless consumption with debt, both household debt payments and consumer debt outstanding remain lower than their pre-recession levels.
Businesses have begun to ramp up operations as consumers re-open their wallets: industrial production saw an almost unbroken rise over the course of 2010 and stands about 5 percent off its previous high. Corporate profits reached an all-time high at the beginning of 2010, and business output has risen to a level less than 2 percent off its 2007 peak. It’s true that some indicators are still recovering, and the weakness of the labor and housing markets is undeniable. But these aren’t necessarily problems with demand.
As Tyler Cowen has noted, part of the explanation for weak hiring lies in improved productivity. Businesses, having presumably shed their least productive workers during the recession, have figured out how to do more with less. Business sector productivity in 2009 rose at immense levels, the highest rate since the heady days of the tech boom, setting the stage for the return to GDP growth the U.S. economy experienced in late 2009 and 2010.
The demand-centered argument also mistakes the cause of persistently slow borrowing by businesses. It’s true that private investment, though rising, remains about 16.5 percent off its peak, and corporate America is sitting on some $2 trillion in cash and liquid assets. But if demand were truly weak, how could corporate profits have reached record highs in 2010 as sales strengthened? Indeed, the National Federation of Independent Business’s small business confidence index, though easing slightly in December, hit a 3-year high the previous month. What really has business owners riled is uncertainty over regulation and taxes, a problem that will persist until policymakers enact meaningful, long-lasting reform.
It’s true that the simple diagnosis of insufficient aggregate demand as the problem is compelling. After all, it lends itself to an equally simple prescription: more stimulus along the lines of “cash for clunkers” and tax subsidies to goose demand for housing. Unfortunately, it doesn’t take into account the subtle issues facing the economy, from uncertainty surrounding regulation and tax law, lingering risk-aversion, and structural changes in the labor market. These are problems that can’t be solved by releasing another flood of cheap money into the economy. More importantly, a single-minded focus on spurring demand may actually hurt the nascent recovery. Measures like the 2009 stimulus are likely to fruitlessly expand the government’s crushing debt burden while producing little substance.
By comparison, showing a measure of restraint as the economy heals will create stable growth. This means curtailing unsustainable spending, enacting permanent tax reform and cutting back on onerous regulation. By continuing to push fiscal and monetary stimulus, progressive commentators are demanding too much from the economy. Consumers are coming to life, though perhaps more slowly than some would like, and business is following close behind. Let’s not allow more misguided efforts to speed the recovery to delay it even further.
David Godow is a research assistant at Reason Foundation.