The Magazine

Obama's Bad Bets

"Recovery Summer" goes bust

Aug 23, 2010, Vol. 15, No. 46 • By JAMES PETHOKOUKIS
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Declaring a “Recovery Summer” victory tour at the start of June must have looked like a pretty safe wager for the Obama administration. The economy seemed to have shifted firmly into gear during the spring. Lawrence Summers, director of the National Economic Council, told the Financial Times in early April that the economy was “moving toward escape velocity. You hear a lot less talk of ‘W’-shaped recoveries and double-dips than you did six months ago.”

Obama's Bad Bets

Jason Seiler

A big reason for White House optimism was a stronger job market. The economy added an average of 320,000 net new jobs a month during March, April, and May, about half of them in the private sector. Granted, the unemployment rate still hovered close to 10 percent. But if the economy kept growing at a 3 percent annual clip or greater—creating lots and lots of new jobs in the process—unemployment would eventually fall, perhaps dramatically. As one White House insider remarked upon reviewing all the macro-indicators and then evaluating the economic team’s performance, “It looks like we got things just about right.”

Since then, however, the economy has fallen back to earth, and “Recovery Summer” looks more like a bad bet. Private sector job growth has fallen by two-thirds, and the unemployment rate is still at a sky-high 9.5 percent. And if the size of the U.S. workforce, as measured by the Labor Department, had stayed constant since April—instead of shrinking by a million—the unemployment rate would be 10.4 percent. Jobless claims are at their highest level since February. Worse yet, the expansion is decelerating. After growing by 5.7 percent in the final quarter of 2009 and 3.7 percent in the first quarter of 2010, GDP advanced by just 2.4 percent from April through June, according to the Commerce Department. And new data show the final second-quarter number may actually be closer to flat, with growth for the rest of the year just 1 to 2 percent at best.

The White House didn’t count on a summer swoon. Then again, it has suffered bouts of premature and unfounded economic optimism before, a malady that has led it to make a number of losing bets and faulty assumptions—which, in turn, have created an even worse environment for growth and jobs. Among them: 

High unemployment is a psychological anomaly. Republicans love to mock the now-infamous chart prepared by administration economists that showed the $862 billion stimulus would prevent unemployment from hitting even 8 percent. But the White House has continued to be overly hopeful about jobs. Here’s why.

Obama advisers noticed that the Great Recession seemed to be violating an economic rule of thumb called Okun’s Law (named after JFK adviser Arthur Okun), which describes the relationship between economic growth and unemployment. As bad as the recession was, unemployment shouldn’t have risen to 10.1 percent, according to Okun. Maybe just 9 percent or so. The administration’s explanation for the overshoot: Panicky businesses shed workers willy-nilly because they feared another Great Depression.

But now with the worst behind and the economy growing again, there should have been a “catch-up” phase during 2010 when job growth would far exceed GDP growth. (That, even though there’s no historical precedent for such an Okun mean reversion.) Yet revised GDP numbers show that the statistical fit between unemployment and growth has actually been much tighter than Team Obama first calculated. Unemployment rose so much simply because the downturn was deeper than preliminary numbers showed. Without much stronger growth, unemployment will stay high.

- America has economic immunity. The White House is no fan of the idea that the U.S. economy has entered a stagnant economic state, what Pimco bond guru Bill Gross has labeled the “New Normal.” It describes a situation where debt overhang after a financial meltdown forces consumers and businesses to retrench for years. The result is a lengthy period of slow economic growth, high unemployment, and big budget deficits. 

There’s plenty of academic research to back Gross up. The economists Kenneth Rogoff of Harvard and Carmen Reinhart of the University of Maryland have found that the aftermath of bank crises in places like Scandinavia and Japan is usually marked by “deep and lasting effects on asset prices, output, and employment.” Similarly, the Cleveland Federal Reserve Bank concluded that such banking events cause “negative long-term effects on the economy, such as slow growth, high interest rates, and lower living standards.” 

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