The recent history of the world economy has been one scarred with recurring crises. The financial crisis of 2008 delivered a severe blow to the global economy, but it would be dwarfed in 2020 by the recession induced by the Covid-19 pandemic. In both instances, economists largely agreed upon the urgency of substantive expansionary monetary and fiscal policy. Crucially, policymakers in 2020 possess an advantage over those of 2008: a chance to learn from the response to the financial crisis of 2008. When considering the US response to the Covid-19 recession, however, it becomes clear that many US policymakers are repeating the mistakes of 2008. While the Federal Reserve has continued using its largely effective tactics from the 2008 crisis, Congress’ failure to swiftly pass a second stimulus package threatens to prolong the recovery.
Despite some early failures, by late 2008 the Federal Reserve had embarked on a substantive and aggressive response to the unfolding recession. In December of 2008, the Fed lowered the federal funds rate to 0 percent and declared their intention to keep rates low, stating unequivocally that the focus of Fed policy would be to “stimulate the economy through open market operations and other measures.” The “other measures” referred to a policy known popularly as ‘quantitative easing,’ a controversial tactic in which the Fed directly purchased securities from troubled banks. None of these measures were universally accepted: a group of prominent conservative economists decried these actions in 2010, stating that they risked “currency debasement and inflation.” However, the Fed’s aggressive action was largely successful. A study from the Center on Budget and Policy Priorities estimated that the Fed’s actions prevented real GDP from declining by up to 6.5 percent and unemployment from reaching 12.5 percent. Another study found that the implementation of quantitative easing successfully lowered yields on mortgage-backed securities and long-term Treasury bonds. The inflation which so worried the signatories to the 2010 open letter never materialized: inflation stayed stable between about 2-3 percent. The effectiveness of the response showed that central banks could effectively respond to a crisis by taking decisive and creative action to preserve liquidity.
The Congressional response to the crisis of 2008 was more complicated. In 2008 and 2009, Congress acted quickly to pass large stimulus bills, most notably the American Recovery and Reinvestment Act of 2009. These stimulus packages were incredibly expensive: the Congressional Budget Office estimated that ARRA alone would cost $831 billion over ten years. However, the CBO also estimated that the ARRA created up to 1.6 million new jobs and raised real GDP by up to 3.2 percent in the third quarter of 2009. By all accounts this was another success story: the federal government had intervened in a cratering economy and saved it from disaster. But Congress would soon lose its commitment to further stimulus. When Republicans took control of the House of Representatives after the Tea Party’s electoral victories in 2010, growing public skepticism over deficits put an end to further stimulus. In fact, Congress would move in the opposite direction: the Budget Control Act of 2011 cut spending by $1 trillion over ten years. The urge towards spending cuts was driven by prominent Republicans such as Senators Mike Lee (R-UT), Rand Paul (R-KY), and Lamar Alexander (R-TN), who in 2011 threatened in an open letter to refuse to raise the debt ceiling without spending cuts. Similarly, House Budget Chairman Paul Ryan proposed $4 trillion in spending cuts in 2011. This sudden turn towards belt-tightening austerity among top Republicans hamstrung the recovery. The Hutchins Center estimated that federal policy after 2010 actually subtracted from GDP growth instead of growing it. The recovery from the Great Recession took 51 months: longer than any of the last three recessions. The case of 2008 provided a perfect cautionary tale to lawmakers: failure to commit to stimulus during a recession could drastically slow the recovery.
When the Covid-19 pandemic first hit the United States and the economy crashed, policymakers rushed to respond with the echoes of 2008 in the background. For a time it seemed as if both the Federal Reserve and Congress were prepared to take aggressive action. In March the Fed announced it was lowering the federal funds rate to 0 percent and that it intended to engage in quantitative easing purchases of up to $700 billion. Congress also moved quickly, passing the CARES Act in March. The CARES Act received overwhelming bipartisan support, passing the House near-unanimously, and aid to individuals provided by the CARES Act did a great deal to cushion vulnerable workers and to spur economic growth. A study from economists at the University of Chicago suggested that government policy actually resulted in poverty falling during the pandemic, and a survey of economists in July revealed wide support for continuing its key provisions.
Despite these early successes, the Federal Reserve and Congress would soon split in their approach to combating the recession. The Federal Reserve announced in September interest rates would stay near 0 percent until 2023, and Chairman Jerome Powell implored Congress in a speech to pass a new stimulus. However, Congress has yet to take his advice. The main barrier appears again to be deficit fears among top Congressional Republicans. Despite the exhortations of President Donald Trump, who after some equivocation came out strongly in favor of more stimulus, Republicans in the Senate continue to resist. Many of the same deficit hawks from 2010 have continued to fight additional spending. Senators Mike Lee and Rand Paul voted no on the original stimulus bill and Senator Lamar Alexander opposed additional stimulus as recently as October. But the economy cannot afford Congressional inaction. As of September the unemployment rate remained almost 8 percent, and job growth has slowed. The Federal Reserve’s commitment to bold action will help, but in absence of a cooperative Congress, its power is limited. A failure to act from Congress could kill the recovery in its infancy. While it’s too soon to know what effect a delayed stimulus will have on the economy, the gridlock of the past few months has shown that many Republicans in Congress still have not absorbed the lessons of 2008 about the importance of timely stimulus.
At the beginning of the financial crisis of 2008, policymakers were faced with an economic downturn of a magnitude that had not been seen in almost eighty years. Their response required them to take creative and unprecedented action, and the effectiveness of many of those techniques was still unknown. The great advantage of modern policymakers over those of 2008 is that the efficacy of those techniques is now well known. Congress, led by Senate Republicans, appears intent on squandering this advantage by ignoring the lessons of 2008. If Congress is serious about ending this recession and passing a second stimulus package, the deficit hawks need to go. If, on the other hand, Congress fails to learn from the mistakes of history, our nation is surely condemned to repeat it.
Photo: Image via Flickr (LunchboxLarry)