Kick-Starting Employment J. Bradford DeLong Professor of Economics, U.C. Berkeley Research Associate, NBER http://delong.typepad.com/ brad.delong@gmail.com
March 30, 2009
Unemployment is currently rising like a rocket, because businesses that normally would be expanding and hiring are not, and those businesses that would normally be contracting and shedding workers are doing so very rapidly. Businesses that ought to be expanding and hiring cannot, because the depressed general level of financial asset prices prevents them from borrowing money or selling bonds on profitable terms. In response, central banks should purchase government bonds for cash in as large a quantity as needed to push their prices up as high as possible. Expensive government bonds will shift demand to mortgage or corporate bonds, pushing up their prices. Even after central banks have pushed government bond prices as high as they can go, they should keep buying government bonds for cash, in the hope that people whose pockets are full of cash will spend more of it, and that this will directly pull people out of joblessness and into employment. In addition, governments need to run extra-large deficits. Spending – whether by the United States government during World War II, following
1
the Reagan tax cuts of 1981, by Silicon Valley during the late 1990’s, or by home buyers in America’s south and on its coasts in the 2000’s – boosts employment and reduces unemployment. And government spending is as good as anybody else’s. Finally, governments should undertake additional measures to boost financial asset prices, and so make it easier for those firms that ought to be expanding and hiring to obtain finance on terms that allow them to expand and hire. It is this point that brings us to US Treasury Secretary Timothy Geithner’s plan to take about $465 billion of government money, combine it with $35 billion of private-sector money, and use it to buy up risky financial assets. The US Treasury is asking the private sector to put $35 billion into this $500 billion fund so that the fund managers all have some “skin in the game,” and thus do not take excessive risks with the taxpayers’ money. Private-sector investors ought to be more than willing to kick in that $35 billion, for they stand to make a fortune when financial asset prices close some of the gap between their current and normal values. If the fund does well over the next five years – returns profits of 9% per year –private investors get a market rate of return on their very risky equity investment and the equivalent of an “annual management fee” equal to 2% of assets under management. If the portfolio does less well – profits of 4% per year – the managers still get a healthy but sub-market return of 10% per year on their equity. And if the portfolio does badly – loses 1% per year – they lose roughly 70% of their investment. Those are attractive odds. Time alone will tell whether the financiers who invest in and run this program make a fortune. But if they do, they will make the US government an even bigger fortune. And 2% of assets under management is an annual fee that many sophisticated investors have been willing to pay private hedge funds – topped off with an extra fee of 20% of annual profits, which the Treasury is not paying. The fact that the Geithner Plan is likely to be profitable for the US government is, however, a sideshow. The aim is to reduce unemployment. The appearance of an extra $500 billion in demand for risky assets will 2
reduce the quantity of risky assets that other private investors will have to hold. And the sudden appearance of between five and ten different government-sponsored funds that make public bids for assets will convey information to the markets about what models other people are using to try to value assets in this environment. This sharing of information will reduce risk – somewhat. When assets are seen as less risky, their prices rise. And when there are fewer assets to be held, their prices rise, too. With higher financial asset prices, those firms that ought to be expanding and hiring will be able to get money on more attractive terms. The problem is that the Geithner Plan appears to me to be too small – between one-eight and one-half of what it needs to be. Even though the US government is doing other things as well –fiscal stimulus, quantitative easing, and other uses of bailout funds – it is not doing everything it should. My guess is that the reason that the US government is not doing all it should can be stated in three words: Senator George Voinovich, who is the 60th vote in the Senate – the vote needed to close off debate and enact a bill. To do anything that requires legislative action, the Obama administration needs Voinovich and the 59 other senators who are more inclined to support it. The administration’s tacticians appear to think that they are not on board – especially after the recent AIG bonus scandal – whereas the Geithner Plan relies on authority that the administration already has. Doing more would require a legislative coalition that is not there yet.
3