Wednesday, October 24, 2012

It’s Past Time to Stop Blaming Bush


The Obama campaign blames today’s economic doldrums on past Bush policies. But this rhetoric doesn’t square with the record.
With the presidential campaign turning white hot, the decade-old “Bush tax cuts” are attracting more blame than ever for the post-Bush economy. Because one facet of Romney’s tax reform proposal is a reduction in all income tax rates, the Obama campaign has been equating it with the “failed policies of the past” (most notably the Bush tax cuts), which allegedly created the mess we’re in. A frequent line in Obama’s stump speeches has been that Romney’s party “drove the car into the ditch... [and] now they want the keys back.” Further, says the Obama campaign, the ditch would have been much deeper had the stimulus package — the American Recovery and Reinvestment Act of 2009 (ARRA) — not halted the economy’s decline early in 2009.
Neither of these assertions squares with the record, however.

The “ditch” in question is unmistakable in the figure below; it is essentially the gap between the blue line, our economy’s real gross domestic product, and the red line, our economy’s theoretical potential — i.e., where economists estimate GDP would be if everyone who wanted a job had one.
The financial crisis of 2008 precipitated the Great Recession of 2008, indicated by the large gray area in Figure 1. But that begs the question: what caused the financial crisis? Was it the Bush tax cuts? Was it Bush-era deregulations? Was it a combination of both? Did the stimulus package Obama signed into law in early 2009 stop the bleeding, thereby preventing a second Great Depression?

What Caused the Crisis and What Didn’t
Several factors caused the financial crisis of 2008, by now the subject of many books and scholarly papers. The three mentioned most frequently are that: (1) central banks ignored a growing asset bubble in the housing market, which peaked and began to burst in 2007; (2) home ownership had received wide, bipartisan support on both sides of the Atlantic, contributing to the false belief that home prices would continue to trend upward indefinitely; (3) so-called financial innovations, such as securitization of mortgage loans and creation of poorly understood derivatives, created large bubbles of leverage and risk on the balance sheets of banks and shadow banks.
Another argument — popular but controversial — also assigns blame for the financial crisis to the repeal of key banking restrictions in the Glass-Steagall Act. (For details, see Peter J. Wallison’s piece debunking this popular argument.) In any case, the key restrictions in question were repealed in 1999, before Bush took office, as shown in Figure 1.
The Bush tax cuts, however, cannot be held responsible for creating any of the above conditions that led to the collapse of the housing market in 2007-2008. Although some have blamed the tax cuts for at least a share of the deficits and debt, and others have given them credit for a share of the economic recovery from 2003-2007, the financial crisis resulted from the bursting of the housing bubble, not the Bush-era tax cuts or deregulation.

What Ended the Financial Crisis and What Didn’t
After the housing bubble burst, the government took many actions in rapid succession, especially in the closing months of 2008. (The St. Louis Fed has posted a detailed timeline of events.) Figure 1 above notes two key actions taken in 2008 to prevent the recession from turning into a collapse: dramatic easing of monetary policy by the Federal Reserve and a large fiscal package (TARP) to shore up the banking system’s balance sheets. By the end of 2008, real output had stopped declining; the recession ended by June 2009.
The stimulus package, ARRA, was signed into law just as the recession was ending. As the word “recovery” in its name implies, its intent was to stimulate our economy’s return to its potential — not to prevent an economic collapse that had already been prevented.
A Tale of Two Recoveries: Reagan and Obama
ARRA was passed to get the economy moving again, similar to previous recoveries from recessions. The deepest recession and subsequent recovery in recent decades happened in Reagan’s first term and is shown in Figure 2. Recovery back toward potential output levels was rapid and steep.

By contrast, the pattern of recovery from the 2008 recession (back to potential economic output levels) has so far been anemic, as shown in Figure 3.
The stimulus package had been expected to yield a “Recovery Summer” in 2010 — but two years later, the economy is still operating well below its potential.
Although the Obama campaign blames today’s economic doldrums on past Bush policies, that rhetoric doesn’t square with the record. What precipitated the financial crisis was not the Bush tax cuts, but the bursting of a housing bubble caused by other factors; what prevented the economy from collapsing into a second Great Depression was late-2008 action by the Fed (easing) and Congress (TARP) — not the stimulus of 2009 (ARRA). And lastly, Figure 3 makes one thing clear: if it is possible for fiscal intervention by the government to move the economy back to its potential — as opposed to enabling, then trusting, private-sector innovators to do that job — the stimulus of 2009 has so far not been an effective way of getting there.
Steve Conover retired recently from a 35-year career in corporate America. He has a BS in engineering, an MBA in finance, and a PhD in political economy. His website is

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