GOP’s ignorance of economics: Even more dangerous than realized

Conservatives' inflation-mania and deficit-hawking are doing long-term damage to the economy, a new report explains

SEAN MCELWEE

Imagine a world where Republican politicians understood economics. In 2008, Obama is elected to the Presidency and proposes a $2 trillion dollar stimulus program. This creates a deficit, but it’s not a problem because Bush hadn’t cut taxes, so the government has been running surpluses for 8 years. States happily take the money to invest in education, infrastructure and services. Hundreds of billions of dollars fund green jobs and worker-retraining programs keep down the numbers of long-term unemployed. The minimum wage is $10 and pegged to inflation, the EITC is expanded. The economy turns around slowly, but an active Fed keeps interest rates low, focusing with laser precision on unemployment.

None of this happened. Instead, the U.S., after a short bout of stimulus turned to a sequestration, one that has certainly hobbled the economy, and may actually increase deficits by slowing economic growth (this happened in Britain). The Fed has been barraged by inflation hawks, but has managed to keep strong in the wake of foolish economic advice. Republicans have fought the stimulus and Governors like Chris Christie nixed crucial infrastructure projects. The minimum wage is stuck at $7.25 an hour and fast food workers languish in poverty.

It may seem like these two worlds won’t matter much in five years. Certainly deficits will be higher in the second, GDP lower, workers less safe, but eventually, the economy will bounce back. A new paper by Dave Reifschneider, William L. Wascher and David Wilcox argues the opposite: the prolonged downturn following the “Great Recession” has likely caused long-term economic damage. The paper is primarily about the implications for monetary policy, since it’s written by three members of the Federal Reserve Board, but the most important point is that the recession has done permanent damage to the economy.

In economic jargon, what the economists describe is “hysteresis,” which first came from a 1986 paper by Oliver Blanchard and Lawrence Summers entitled, “Hysteresis and the European Unemployment Problem,” in which the authors argue that large demand contractions can have long-term effects on unemployment and economic growth. Policymakers should intervene to prop up demand to limit long-term damage to the supply side of the economy. As Gavyn Davis notes in the Financial Times, the implication is that, “In a reversal of Say’s Law, and also a reversal of most US macro-economic thinking since Friedman, demand creates its own supply.”

full article
http://www.salon.com/2013/11/15/gops_ignorance_of_economics_even_more_dangerous_than_realized/