An audience of about 80 got a fascinating behind-the-scenes glimpse of how U.S. economic policy is made at a conversation with two of the principals.
Edward Lazear chaired the Council of Economic Advisers for George W. Bush from 2006 to 2009, dealing with the financial crisis as it emerged. Christina Romer took over the role—and the crisis response—in 2009 with the incoming Obama administration.
Moderator Lars Peter Hansen began the discussion by asking how policy disagreements were resolved. Lazear and Romer shared views of very different environments.
“I was a second-termer,” Lazear said. “By then, things had settled down and shaken out and people understood what their roles were and what the process was.”
Another plus: “I was the only chief economist in the organization,” Lazear added, explaining that other key players did not come from an academic economics background. “We were strong complements. They they generally deferred to me on economics, and I to them on politics.”
Still, there were disagreements, usually managed via the very formal policy structure the Bush administration relied upon. Issues were addressed in a bottom-up process, with disagreements worked out at each level before briefing superiors and moving the issue up to the next level. President Bush was the final arbiter.
Romer reported the opposite experience: “We had lots of economists and lots of strong views. We were in transition, so there was no formal process. It was very much a free-for-all.”
“President Obama liked to have people with different opinions argue their positions. His problem was, we didn’t know when to stop arguing,” she said with a laugh.
“President Obama loved evidence. The way you won an argument was by having the best evidence. It made you work really hard on your economics. If the information wasn’t there, you went out and got it.”
“One of the things that is so neat about the CEA is that it was set up in 1946 precisely to bring academics like Eddie and me into the administration,” Romer continued. “You’re supposed to come in and bring the best expertise from economics.”
“You wouldn’t think that an organization whose staff turns over every year or two can function, but it does,” Romer continued.
The Role of Research
Asked about how the CEA used formal economic models, both agreed that they turned to academic research for the evidence they needed. Throughout the conversation, in fact, Romer cited careful microeconomic studies about the impact of stimulus spending, fiscal policy, and other topics.
“We relied on literature constantly,” Lazear said. “You’re dealing with all these problems and you just don’t have enough time to start doing original research.”
For example, as the financial crisis emerged, the Bush team decided a stimulus package was needed. “The question was, how would we do it— a tax break, tax credit, transfer, or rebate. To resolve differing opinions, we used evidence, real evidence. We used [studies in] The Journal of Political Economy.”
Existing research is also critical because no adviser can be expert on all the issues, Lazear said. “Weird problems come up. One of the first I had to deal with was the avian flu. I knew nothing about bird flu, but it’s a serious problem. We had to think about whether to close borders and if so, to [close them to] goods or to people. There are cost benefit decisions to be made, and you can’t do this on the fly. You have to look to people who have worked on these issues.”
Romer added, “What’s hard is when the world is changing fast and models don’t seem right anymore. A current example is inflation, which has defied models and expectations by remaining stable through a severe global recession. What I thought I knew and what I taught my students for years doesn’t seem to apply,” she said.
Stimulating?
The pair differed on the effectiveness of stimulus spending. Romer, giving credit to the Bush administration for its 2008 tax rebate, said that it didn’t at first glance appear to increase consumer spending. “But, remember that this was when house prices were dropping. Maybe the fact that spending didn’t plummet along with them and stayed flat—maybe that was a victory.”
In discussing the 2009 Recovery Act, she added, “the view I came around to was that it was fairly effective and did what we expected in terms of GDP; it was just not big enough in relation to the problem.”
Lazear noted that the impact of the stimulus remains hard to gauge, because coming up with a reasonable counterfactual is difficult. People have produced evidence to speak to this point, but in his view, it has not been compelling. “One question in designing the stimulus was, ‘what is the marginal propensity to consume?’” Lazear said. For maximum stimulus effect, “the general consensus is that you should give money to poor because they will spend it, while the rich will bank it.”
However, the best evidence suggested that the propensity to consume is the same among income brackets, except for the very rich.
Referring to the same study Romer mentioned estimating the impact of stimulus, Lazear said, “I basically concluded the opposite: the stimulus was not very effective.”
Lazear said the outgoing Bush administration considered an additional stimulus, but opted against infrastructure spending because projects are rarely “shovel ready” and take too long to funnel dollars into consumption.
Romer agreed: “We all love infrastructure but it is inherently slow. The nice thing about pairing it with state transfers and tax breaks is that those are really fast.” The Obama package ended up split roughly evenly across all three.
“Good government says you ought to have a long range plan for fiscal stimulus and infrastructure spending,” Romer added. “We’re trying to get more knowledge so we can do [stimulus] better. We’re getting better and better studies by a new generation of scholars who wouldn’t count themselves as Keynesians or non-Keynesians.”
Specifically, she mentioned a careful microeconomic cross-state study on defense spending showing that states that that got more defense spending have a greater response in terms of employment and output.
Lazear again disagreed, saying that he thought the study was flawed and showed only a pure substitution effect. Those who get money spend more than those who don’t, but that doesn’t mean that aggregate spending rises. It may be that those who don’t get money reduce their spending as they implicitly fund those who do
Which Policy Tools?
Asked if current discussion focuses too much on monetary policy and neglects fiscal policy, Romer argued that both tools are needed. “In the current climate, when it is so hard to get anything through Congress, monetary policy is the only game in town,” she noted. “When you look at Europe, you see the same situation. There is no fiscal union to coordinate fiscal policy, but there is a strong European Central Bank for monetary policy.”
Turning to the topic of financial regulation, both voiced a need for greater capital requirements on financial institutions. Lazear said excessive leverage was “the real culprit” in the financial crisis, and neither the Dodd-Frank Act nor Basel III dealt with it effectively.
Romer agreed and mentioned that money market mutual funds might be the next problem. Overall, she said, from a regulatory perspective, markets were in better shape and stronger than five years ago.
Looking to the future
Asked for forecasts for the economic future, both experts were fairly optimistic in the long term.
Short-term, Romer said she is more nervous than some. “We’ve come through through hell; we’re starting to grow but not back to full life,” she said. “What I see going on in in next couple of years is more of the same.”
She expressed worry about “the chances of Europe melting down” and the possibility of “something silly,” such as another government shutdown, arising out of political gridlock.
“But give me the five to ten-year window, and I’m fairly optimistic. The fundamentals are still good. We have unbelievably good universities, still coming up with ideas” that will fuel innovation and economic growth, she said.
“I agree, but I’m a little more optimistic,” Lazear said. He noted that innovation and growth show up in markets before they show up in forecasts of future GDP growth, and market signs are encouraging.
“In the long run, I take the same view as Christy: I’m not one of these guys who says all the good things have already been invented,” he said.
To an audience question about the chances for political agreement, both agreed political ill will was always a hurdle, but that there were plenty of examples where compromise and good will carried the day.
The Troubled Asset Relief Program was adopted by “a president who was doing something antithetical to his party and his views,” Lazear pointed out. “Bush and Kennedy worked together to propose an immigration reform bill. Clinton passed NAFTA, which was negotiated by Bush Sr., and put his own his political capital on line. President Obama put through free trade agreements George W. Bush negotiated, but couldn’t get passed by Congress.
“We shouldn’t be so pessimistic throw up our hands and say Washington not doing anything,” he concluded.
Romer added that it is helpful to remember that policymakers are often just “trying to do the right thing with the best evidence they have.”
–Toni Shears