Galbraith: Thoughts on a Plan B

The following is a post by James K. Galbraith as originally published this Monday at the New America Foundation’s website.

In July 2008, in a memorandum for the Obama campaign team and later published in Challenge,  I wrote as follows:

If the above analysis is correct, the political capital of the new presidency risks being depleted, quite quickly, in a series of short-term stimulus efforts that will do little more than buoy the economy for a few months each. Since they will not lead to a revival of private credit, every one of those efforts will ultimately be seen as “too little, too late” and therefore as ending in failure.

Painful though it is to repeat those words, the question remains: what can be done now?

1. First of all, do not rely on the Federal Reserve. Quantitative easing is eyewash – a fantasy solution.  And the zero interest policy is also not expansionary.  These policies relieve banks of bad assets, provide them with cheap funds, and make them seem profitable in spite of the fact that they are doing nothing constructive.  They do not increase lending to the public and therefore have no effect on spending.  Further, the zero interest rate policy reduces total spending, since it cuts interest incomes and therefore spending from interest income.

Eventually the short-term interest rate should be raised, and banks “jawboned” to raise the interest rates they pay on deposits and CDs.  This is an expansionary policy under appropriate conditions:it squeezes bank profits and encourages them to take more business risk. As in 1994, banks that are truly solvent will seek to keep their earnings up by making commercial and industrial loans – the legitimate risk-taking that powers the private economy.

2.  As for the banks that are not truly solvent, who needs them? They are a burden, kept alive by the raw exercise of political power.  It is past time for clean audits, for definitive market valuation of toxic assets, and for the downsizing of bloated banks, under new top managers – paid appropriately less than the current crop. Meanwhile we need full investigation and prosecution of the vast swindles in the mortgage markets.

3.  Restructure household debts.  Restoring financial health to households will be a long, slow process, but it must start.  Let’s have a new bankruptcy reform ending the indentured servitude imposed under Bush, and also enact the right of judges to cram down mortgage payments in bankruptcy.  Let’s enact right-to-rent for foreclosed homeowners, and direct Fannie Mae and Freddie Mac to reset and restructure mortgage payments aggressively.

4.  Let people retire!  Full employment is the right goal but job losses have been so severe that practically we are not going to get there by any known measures. So we need to choose who gets the first crack. The right thing is to allow older workers who wish to exit the labor force to do so, opening jobs for younger people. Enact a three-year window during which workers aged 62 and older could retire on full Social Security.  Enact Medicare at 55, allowing workers with health problems but sufficient resources otherwise to escape into a comfortable retirement.

5.  Help the States.  So far, help for states in the stimulus program has only offset the job cuts imposed by falling revenues and balanced-budget requirements. There must now be fiscal assistance to end, finally, the budget crisis of states and localities.  Federalizing Medicaid may be the most effective and practical way to achieve this. The alternative is open-ended general revenue sharing: on the condition that states neither raise nor lower their tax rates, the federal government should supply the funds required to close their budget gaps and to maintain public services at baseline levels, for the duration of the crisis.

And if deficit hysteria could be overcome, the following steps should also be taken:

6.  Tax relief for workers.  The American Recovery and Reinvestment Act (ARRA) offset payroll taxes through the income tax.  This policy should be extended, expanded, or even altogether replaced by a full payroll tax holiday, granting all working families an increase in after-tax incomes of over eight percent up to the limit of the FICA. To keep the Social Security Trust Fund whole, let the federal government credit it for the taxes — and add the revenues of the estate tax for good measure.  The policy of tax relief for workers should remain in place until unemployment falls below six percent, at which time it can be gradually phased out. Tax relief for the wealthy is a failed strategy that should end now; a higher personal tax rate will induce companies to retain and invest their earnings, as they used to do.

7.  Jobs Programs.  Taking a leaf from the New Deal, let the federal government establish a new Conservation Corps, a Neighborhood Corps to protect, maintain and revitalize (or as necessary demolish) distressed housing, and a Home Care corps to provide services to the elderly in their own homes.   Other suggestions welcome.

8.  Strategic Investments: Energy and Climate Change.  The illusion of stimulus was that the economy would “return to normal” with a little “fiscal boost.”  The reality is that having exhausted (however imperfectly) the 1940s agenda of middle-class housing, the 1950s highways agenda, the 1960s health-care agenda and the 1990s information-technology bubble, the economy needs a new strategic direction.  The clear and pressing priorities are energy and climate change. To address these challenges is a grand task, requiring decades of research, careful planning and many investments, if we are to pass on a livable planet and a decent living standard.  Institutionally it will require new lending agencies to assure that the funds needed are available over the long term. And the work can provide jobs for millions, for many years.

  1. Olivier Travers says

    Wow, Galbraith can actually write something that’s not utter nonsense! Who knew? Points 1 and 2 are spot on, if way belated. I guess Krugman is now solidly leading the Tour of Idiotistan then.Of course when it comes to solutions we’re going back to planned economy La La Land, but at least he’s got part of the diagnosis right on what *not* to do (i.e. what’s been done these last couple of years). France has all the junk Galbraith is advising yet it also has perma-unemployment stuck through decades at similar levels as the current US job crisis. Oh wait JKG, your magic programs have externalities, unintended consequences and opportunity costs too, just like the private sector you like to deride so much, only enforced at the point of a gun.

    1. Edward Harrison says

      Galbraith is right on banks and interest rates. I am less enthusiastic about his ideas on early retirement. I know the “save Social Security” approach is the one being taken by most liberal commentators. But, this flies in the face of the reality, namely that people are going to be in retirement longer and a greater percentage of people are going to be retired. How do we square early retirement with the real resource drain that it entails?I presented this question to a friend who shares Jamie’s position and his response was:”if policymakers simply understood that people out of work represent underutilized capital. Put them to work. In addition, make large public investments in infrastucture, health care, alternative energy, education, basic R&D, transportation, etc. Finally, lower taxes so that individuals have more money in their pockets to fund their own retirements.”For me, the crux of Galbraith’s other agenda items has to do with getting people back to work. Pretty much everyone agrees here. The question is how to do that, especially since the private sector is a mess. Propping up finance, housing and autos is not the way IMO. You can see Stiglitz, another more liberal commentator, making similar noises on housing: of bailing out and propping up specific economic sectors, does the government have a role? I say yes. You say no. I think that’s where we are in this debate generally. It will be hard to get anything close to consensus on this since a large part of the debate is ideological; the economics is less clear.

  2. Element says


    I’ve come to the view that there’s probably not a small-‘d’ depression option for the US (as per your poll) if the US attempts to glide into a stagnation. Why? Unemployment rises inexorably and demand gradually falls and defaults will continue, while asset prices fail to recover.

    Japan did not have this US problem, it was able to stabilize stagnation with high employment. Plus it could change Govt and policy extremely quickly, yet remain politically stable. Thus Japan’s private sector could actually manage orderly reductions in private debt levels.

    But the US already has high unemployment, and it would rise, plus not have amenable politics, so does not get the years needed to unwind private debt, in an orderly process. US Politics would always intervene to terminate the stagnation. You know they would…just listen to the rhetoric this week about “growing for the past 12 months”. It’s the measure of success.

    Japanese public debt grew to 200% of GDP simply maintaining stagnation and acceptable employment levels. Get the unemployment level wrong and you can’t do it.

    But imagine what would occur if the US politically tried to intervene with spending to stimulate GDP to end such stagnation.

    So it seems self-evident to me that sustained stimulated growth is out, and a sustained stagnation is politically impossible, thus an orderly US private delevering is consequently precluded.

    Which means the US will (after a few stimulus spurts) enter a big-‘D’ Depression to delever the private sector debt.

    Hence no glide-path to zero growth small-d depression exists. The only question is how much bigger the public debt gets before this takes place.

    If you have not read the following article, it’s an eye opener about why Real GDP growth stagnates in this situation;

    “What Bernanke doesn’t understand about deflation” – August 29th, 2010 – Steve Keen in Debtwatch

    Keen’s final table is prefaced with, “…to give us some idea of what the next decade or so might hold”.

    BTW, I love this second US stimulus-package that you are having, when you aren’t having a second stimulus package. Seems closer directed to what is needed this time. I hope it makes a difference for people, rather than porked balance sheets, this time around. I was also glad to see Tim being a bit more forthright on PBS Newshour yesterday, a pretty good interview, he cleared the decks for what comes next. Take a look at it if you didn’t see it.

  3. jimh009 says

    Ideas 1-3 are great and long-overdue. Those three alone would be a big, big plus, helping to flush out the bad debt and get rid of the zombie banks and have some honest and transparent accounting. Painful in the short-term, for sure. But in the longer term, it would pay huge dividends.

    As for the rest…all I can say is that it probably isn’t any worse than what’s been done – but, that admittedly is setting the bar awfully low.

    No way I’d take the odds, though, of ANY of his ideas seeing daylight!

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