TERRY GROSS, host:
This is Fresh Air. I'm Terry Gross. "Terrifying" is the word economist Paul Krugman used to describe the recent economic numbers. President-elect Obama warns if we don't act swiftly and boldly, we could see a much deeper economic downturn. Obama has proposed an economic stimulus package of about $775 billion dollars. Some say it could end up costing a lot more. It would include programs to rebuild our infrastructure - roads, bridges, the electronic grid - make public buildings more energy efficient, renovate schools and computerize medical records.
Although many are applauding him for being bold, some say, not quite bold enough; the government should be spending even more. Others say more government spending isn't the answer. We'll be hearing from economists on both sides. Our first guest, Dean Baker, urges Obama to spend even more to revive the economy. Baker is co-founder and co-director of the Center for Economic and Policy Research and author of the new book, "Plunder and Blunder: The Rise and Fall of the Bubble Economy." Dean Baker, welcome to Fresh Air. Let's start with your short take on Obama's proposed stimulus package.
Dr. DEAN BAKER (Co-founder and Co-director, Center for Economic and Policy Research; Author, "Plunder and Blunder: The Rise and Fall of the Bubble Economy"): Well, he's certainly going in the right direction. We clearly need a large stimulus. He's focused on a lot of areas where, I think, we'll have productive spending. First off, state and local governments that are facing shortfalls; he's going to get them money so they don't have to lay off workers, raise taxes. That's a very good thing. He's going to have money for infrastructure. That's a good way to employ people and deal with some of the issues - the backlog of repairs, maintenance on bridges and roads that we need to do. And he's also going to place a priority on green projects - retrofitting buildings, homes, public buildings - so that we use less energy. So, that part of it's very good.
The parts I'm more concerned about - he's proposing a tax cut, roughly $500 a person, similar to the tax cut we had last summer. People didn't spend that much of that tax cut, so I'm not thrilled about that. I don't think it's the worst thing, but it's not going to be terribly stimulatory. It won't create a lot of demand, a lot of jobs. The other tax cuts, the business tax cuts, those, I have to say, I don't fully understand. He's proposing that firms will be able to write off their losses this year against profits going back four or five years. And that's basically a gift to the financial industry and builders, and that's really not something I think we should be doing right now.
So, those are concerns. The biggest concern, though: it's just not large enough. He's talking about 360, 370 billion a year. We're looking at a very, very serious downturn, and by his own estimates, his economic team's own estimates, if this works, we're still looking at an unemployment rate that's over seven percent by the end of 2010. I just don't see it as a very good picture.
GROSS: Now, let me get back to your concern about the businesses being able to write off losses from this year against gains of previous years?
Dr. BAKER: Yeah, currently, under current tax law, you could write off your losses in 2008 against gains in 2007, 2006. This would allow you to go back four years. So, in the event you had a very large loss in 2008, you could go back as far as 2003 to write off your losses against prior profits. There aren't going to be that many firms that have losses that are so big they'd have to go back four years to find profits to write them off against. The one exception, or the two exceptions, I should say, are the building industry, which is incurring very large losses, and of course, the financial industry, where they're having write downs in the tens of billions of dollars in some cases. But those are really big exceptions, and I don't really know that those are industries we should really be looking to favor with tax handouts that don't have any obvious economic benefit.
GROSS: Could it be that some of the really big companies who got money through the bailout will also get this tax advantage?
Dr. BAKER: Absolutely. I'd expect you'd see many of the same companies, certainly a firm like Citigroup, which, obviously, has taken a lot of very big losses and already gotten 45 billion through two different bailouts. They jump to mind as one company that almost certainly would be in that boat that could profit from this sort of tax write-off. There's clearly many, many others, but that's a very big, very visible financial company that would benefit. And in this case, unlike with the money going through the TARP, the bailout, there were at least some conditions. Many of us complained the conditions weren't enough, but in any case, certainly some conditions attached to that money. It's a loan; it's not a grant. In this case, you're just handing money to the banks.
GROSS: What's the downside of giving the tax breaks to businesses? Are you concerned that the money from those taxes was supposed to be part of what keeps the country afloat as other people are getting breaks?
Dr. BAKER: Yeah, well, the research - there's a fair bit of research on the effectiveness of tax cuts to business in stimulating investment and stimulating demand. And it shows it has very, very little effect. Essentially, businesses aren't going to invest because we give them tax cuts. I got a big kick out of what Paul O'Neill, the first Treasury secretary that President Bush appointed, when he was testifying at his confirmation hearings, he was asked about tax cuts, and he said, he doesn't know a single businessperson who invests because of tax cuts. He goes, we're happy if you give them to us, but that's not why we invest. And I think the research pretty much bears that out. So, given that there is a limited amount of money we're going to spend, I think we want to spend it in a way that creates demand, creates jobs, and if we're just handing money to business, it doesn't seem it will have that effect.
GROSS: So, you're saying they use the tax cuts for profits as opposed to investment?
Dr. BAKER: That's right. They're going to use it to pay down debts, to build up their cash reserves. They might pay it out as dividends to their shareholders, but they're not going to invest just because we gave them a tax cut.
GROSS: One of your concerns about the stimulus plan is that it's not enough. In what sense do you think it might not be enough?
Dr. BAKER: Well, we're looking at the steepest downturn since the Great Depression, and again, this is to President Obama's credit, his team put out a very good analysis of what they anticipate the impact of the plan to be. And I have very little quibble with the accuracy of what they're saying. And what they're projecting is that we're going to get the unemployment rate over nine percent in 2010, as a baseline, and given the impact of their stimulus, they're projecting that, by the end of 2010, they'll get the unemployment rate down to somewhere close to seven percent.
And that just doesn't sound very good to me. The conventional estimates of full employment are somewhere around four and a half percent, so that means even after two years, two years from now, we're still going to have an unemployment rate that's still two and a half percentage points above full employment. Or another way to think about it is if everything goes exactly as the Obama administration is predicting, two years from now, we're going to be back where we are today. We're going to be looking at the same sort of unemployment rate that we do today.
Now, on the plus side, they anticipate - their expectation is that it'll be headed downward, but nonetheless, we're going to have an economy in December of 2010 or January 2011 that looks pretty much like what it does today in terms of how many people are working and how many people are unemployed. And that just doesn't look to me like a really good situation to hope for.
GROSS: What signs will you be looking for to see whether the stimulus, if it's passed, is succeeding or not?
Dr. BAKER: Well, right now, the economy's in almost a free fall. It's really frightening to see the numbers come out the last three months. We just had the employment numbers come out for December last week, and we lost another 500,000, 530,000 jobs roughly after losing the same number in November and almost the same in October. This is really, really a very frightening scenario, and what you'd hope is that this is going to stop very quickly.
And I don't know if we'll stop losing jobs the day we pass the stimulus package, almost certainly not, but we'd certainly like to see the numbers, the rate of job loss, slow very rapidly so that, let's hope - it's a disappointment to me that President Obama will not have a package on his desk when he takes office. I'm sure it's a disappointment to him as well, but hopefully, we'll get a package early on in February, mid-February I guess is now the target date, but if we could start getting some money out the door, getting it to state and local governments, hopefully the rate of job destruction will slow by March, and maybe by the summer, you know, we'll maybe be holding our own, not creating, not losing jobs.
That's an optimistic scenario, but we have to get that rate of job destruction slowed because if you're losing half a million jobs a month, that's really a devastating story, and you can't have that go on for very long without really wreaking havoc on your economy and obviously, people are out of work. It's a devastating situation.
GROSS: Obama warned that we face trillion-dollar deficits for years to come, and of course, the stimulus package will be part of what's included in the trillion-dollar deficits. How do you pay off trillion-dollar deficits?
Dr. BAKER: Well, the important point to keep in mind is the deficit matters relative to the size of the economy, and we use these numbers - trillion's an enormous number. None of us - even Bill Gates will never see a trillion dollars in his lifetime. So, this is a huge, huge number. But relative to the size of the economy, it is still large, but it's about six percent of the economy. So, it's not trivial by any means, but it will not be beyond our ability to pay it off. It's also important to keep in mind the alternative, if you don't run the deficits. It's not as though we are somehow making our kids better off, because what that means, simply, is that we are going to have higher unemployment; we're going to be investing less; increasing our capital stock at a lower rate; probably not educating our kids as well.
They're not going to be happy 20 years from now if we can say, well, you have lower deficit, but you didn't get a college education, our roads have fallen apart, our infrastructure - the rest of our infrastructure is fallen apart. That's not the way to make our kids wealthy. So, we really have no choice here. We made a lot of bad decisions over the last 10 or 15 years that have gotten us into this hole, and the question is, what's the best way going forward? And to my mind, there's really not much of a debate on that. I really don't think there is all that much debate among economists that we have to spend a lot of money right now and running big deficits is part of the story. It's unfortunate; it would be better if we weren't in this situation, but given where we are, the best way to get the economy growing and make ourselves and our children better off is to run large deficits.
GROSS: We've been printing more money to increase liquidity. What does that do to the value of the dollar? Is the dollar going to be worth less because we are printing more of them?
Dr. BAKER: Well, it really doesn't have any direct affect on the value of the dollar. The value of the dollar is determined first and foremost by the health of the U.S. economy. It's determined - if we're thinking the dollar relative to the euro, to the yen, it's determined by our trade situation, and that is an issue. It's, again, something I think we neglected over the last decade. We let the dollar get overvalued. We have a very large trade deficit that will cause us problems in years to come. But directly printing money, that's really a very second-order effect, and it's kind of striking that when we really sort of let loose with the printing presses, when the Fed really started injecting liquidity in the system in September and October, the dollar actually rose against most currencies.
So, it's - there's this idea that somebody printed a lot of dollars, the dollar becomes worthless. There's not a direct relationship there. Now, you can tell a story that suppose we had the economy near full employment, the unemployment rate is around four percent, and all our factories are operating at capacity. All the sectors of our economy are pretty much at capacity. And then the Fed was still printing up dollars at a really rapid rate. Then you get the classic story of too much money chasing too few goods and services. And that's a case where you would get inflation; the dollar would lose value.
But we're extremely far from that situation; now we're at the exact opposite. It's almost, you could say, we have too many goods and services being chased by too little money. So, at the moment, at least, that really isn't something that we need fear. That doesn't mean down the road we might not be in that situation where we should be worried about having too much money chasing too few goods and services. But that's not likely to be a concern for at least the next three or four years. We really would consider ourselves lucky, I think, if that was something we had to worry about.
GROSS: My guest is Dean Baker, co-founder and co-director of the Center for Economic and Policy Research and author of the new book, "Plunder and Blunder: The Rise and Fall of the Bubble Economy." We'll talk more after our break. This is Fresh Air.
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GROSS: If you're just joining us, my guest is economist and economics writer Dean Baker. He's the co-founder and co-director of the Center for Economic and Policy Research, and he's the author of the new book, "Plunder and Blunder: The Rise and Fall of the Bubble Economy." You're considered one of the people who spotted that we were in a bubble economy, and therefore, there'd be trouble ahead. When did you realize we were thriving on a bubble as opposed to, you know, solid economics?
Dr. BAKER: Well, I had been following - been concerned about the stock bubble, really, from '97, and that was something that concerned me and concerned me that the Fed didn't take it seriously. But in terms of the more recent bubble, the housing bubble, I first wrote about that in the summer of 2002, and really, what prompted me to look at that was Alan Greenspan had given testimony before Congress where he insisted that there was no housing bubble. I don't know how the issue had come up originally, but I read his testimony and read his reasons for saying everything was just fine, and it really didn't make any sense.
So, at that point, it occurred to me that we did have a substantial bubble; it was cause for concern in 2002. But of course, it kept growing; house prices didn't finally peak until 2006. So, through that whole period, I was sort of jumping up and down, yelling, yes, we have a bubble. It's going to be bad news. It's going to collapse, I don't know when, but when it does, it won't be pretty. And obviously, it went on considerably longer than I'd expected.
GROSS: How do you recognize a bubble?
Dr. BAKER: Well, it's not always going to be easy, but in both the cases of stock and housing bubbles, I think it was, in fact, very easy. And basically, when you have some large sector of the economy - like stock, like housing - and you could look back at long-term trends, and you see a deviation from long-term trends - in the case of housing, house prices, by their peak in 2006, had risen almost 80 percent above the rate of inflation, we had a long-term trend where you could go from 1895 to 1995, where nationwide, house prices had just kept even with the overall rate of inflation. There where ups and downs over that period, but over a 100-year period, house prices had moved in step with the rate of inflation.
So, when you suddenly get this huge divergence - after 100 years, house prices had kept even with the rate of inflation and suddenly, they jumped 80 percent above the rate of inflation, well, you either need something very obvious in the economy that would say conditions in the supply in the housing market or conditions in demand in the housing market had changed in a really big way, or it's a bubble. And in the case of the housing market, if you look closely at the conditions of demand, we didn't have particular rapid population growth, household formation, the baby boomers, already - we already had our own households long ago in the '70s or '80s, not in the late '90s and this decade. So, you didn't have a demand story. Supply story, we were building houses at a near record rate. So, there was really nothing in the fundamentals that could've explained that sort of run-up.
And as a final check, owning and renting are interchangeable to some extent. They are different markets, but there is always trade-offs that people go from being renters to owners and vice versa. So, if it was the fundamentals of the housing market, you should've expected to see a big run-up in rents, as well. And when you looked at rents, there was almost nothing going on there. So, to my mind, it was very easy to see that prices were being driven by a bubble rather than the fundamentals in the market.
GROSS: Did the bubble that you thought you saw in the housing market have corresponding things going on in the financial markets?
Dr. BAKER: Absolutely. Again, one of the stories, and just only definitional, if house prices rise out of line with fundamentals, then it becomes harder for people to buy homes. So, someone who would have otherwise been able to buy a standard middle-class house, they now have to stretch to do that. So, what that meant was you had to see new types of mortgages coming out there, changing rules, allowing people to buy homes with less money down. We saw that. And then, of course, we saw this huge increase in adjustable-rate mortgages, option-adjustable-rate mortgages, various types of exotic mortgage instruments that allowed people to get much more overstretched than would have been possible by the standard rules in the financial industry going back, say, 10, 15, 20 years.
GROSS: The housing bubble and the financial markets collapsed during the Bush administration. But you trace the bubbles back to the Clinton administration. What do you think the Clinton administration contributed to the bubble?
Dr. BAKER: Well, there's two points I'd emphasize here. First off, the pattern of growth that the Clinton administration set itself out on was one of low interest rates. So, what they said was, we're going to cut the deficit; that was one of - President Clinton's pledge and certainly a main focus of his policy once he took office. So, he wanted to get the deficit down and eventually balance the budget, and then, he actually ran a surplus. So, he said, we're going to cut back spending, raise taxes, and so, we'll get the budget deficit down, and then the hope, the reason that was supposed to stimulate the economy is his world-view was that we'd get interest rates down, and that would make it easier for firms to borrow to invest, but also for people to borrow, to consume or buy homes, whatever it might be. So, it was explicitly a low-interest-rate policy. So, that was creating the environment in which you can have a bubble.
The other part of the story was they just didn't take seriously the problem that financial markets left to themselves could get into trouble. So, on the one hand, bubble itself. I mean, there were people who talked about the stock bubble during the Clinton years, and the Clinton administration always dismissed it. They were proud of the fact that the stock market was going to higher and higher levels, that the NASDAQ went to 4,000, then 5,000. So, they were dismissive of the idea that you actually could have a bubble.
Also, they removed many of the constraints that had existed on the financial sector. So, in 1998, they pushed through the repeal of Glass-Steagall, the Depression-era legislation that prevented the merger of insurance companies and investment banks and commercial banks that ended up facilitating some of the practices that led to the housing bubble. The other action that they did, an important action that they did, was Clinton supported a law that prevented the regulation of credit default swaps and other derivative instruments. And that, of course, helped to create the problem we had with the explosion of credit default swaps during this decade, where, at their peak in 2007, the nominal value of the credit default swaps outstanding was $72 trillion, almost five times the size of the economy. So, those were policies that the Clinton administration pursued that created the environment in which both the stock bubble, and then, subsequently, the housing bubble, can grow.
GROSS: I had asked you about what the Clinton administration did to start or contribute to the housing and markets bubbles. What about the Bush administration?
Dr. BAKER: Well, the Bush administration sat back as the housing bubble grew and did nothing to crack down on either the growth of the bubble directly - I would have loved to have seen Alan Greenspan at the Federal Reserve Board take steps, but President Bush certainly could have, also. But they also ignored the growth of these various derivative instruments, credit default swaps being the big villains in many people's eyes, mine also, and just said that everything was fine. And they were opposed to any sort of regulation that might have reined in the bubble before it grew to such destructive proportions that it really could bring down the whole economy.
GROSS: Of course, the legislation that allowed those derivatives and other complicated financial instruments relating to mortgages, allowed them to go unregulated, that legislation was passed at the end of the Clinton administration.
Dr. BAKER: Absolutely. So, you had the bill authored by Senator Gramm that passed with the support of the Clinton administration that made it impossible for, or at least difficult, for the government to regulate credit default swaps and many other derivative instruments. President Bush, again, he certainly could have raised this as an issue, should have raised this as an issue. And I know that some people in the Bush administration have tried to wash their hands, saying, well, that happened before us. When you see a problem, it's the president's job to be calling attention to it, to ask Congress for legislation. Remember, it was a Republican Congress for most of his administration.
So, if they had recognized the problem, if they had called on Congress to act, there's reason to believe they could have gotten legislation that would've allowed for effective regulation of credit default swaps and other derivative instruments. So, the fact that the legislation originally passed under the Clinton administration - certainly President Clinton deserves his blame for this, they shared the blame - but you can't be president for eight years and say you bear no responsibility. That really doesn't make any sense.
GROSS: Dean Baker is the co-founder and co-director of the Center for Economic and Policy Research and author of the new book. "Plunder and Blunder: The Rise and Fall of the Bubble Economy." He'll be back in the second half of the show. I'm Terry Gross, and this is Fresh Air.
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GROSS: This is Fresh Air. I'm Terry Gross, back with economist Dean Baker. He's the co-founder and co-director of the Center for Economics and Policy Research and author of the new book, "Plunder and Blunder: The Rise and Fall of the Bubble Economy." You know, just about everybody who is near or almost near retirement is in a kind of a panicky state about the amount of money they have lost in their retirement accounts as the market has collapsed. So, what happens if the market doesn't recover soon and a good deal of the baby boom starts retiring with a small percentage of what they thought they were going to retire with? I mean, how do we as a society deal with that?
Dr. BAKER: Well, it's a devastating situation, and this is one of the issues that, I think, many of us had been concerned about because we had the switch from most pensions having been defined benefit pensions back 30 years ago to now almost all pensions being defined contribution - at least, unless you work for the government or a few unions still have defined benefit, but basically everyone else has defined contribution. And what that means is the worker takes the risk, and this was the risk. And you know, many of us were raising this, that something like this could happen. We didn't know the stock market was just going to plunge by 50 percent in a year, but something like that could happen. And this was largely pooh-poohed by most people in policy positions that it was a very unlikely event, and unlikely events do sometimes happen. And the point is this one has enormous consequences.
Now, I would hope that we could do some things to help at least some of these people - you could look to shore up the social security program, at least at the bottom end, increase benefits for people earning or getting less than the median benefit. I mean, we could think of formulas where you could increase those benefits by 10, 15, 20 percent for a period of five years or 10 years. It wouldn't be that large a cost. It could make a very big difference in the retirement security for a large number of people. But we can't replace trillions of dollars of lost wealth like that, and that was a risk that people were taking. And I think most of them didn't realize that because they had been told by the people who are supposed to be experts that this couldn't happen. And unfortunately, the experts were wrong in a really big way, but it's not the experts who pay; it was the people who listened to them.
GROSS: So, if baby boomers decide not to retire as quickly as they'd planned because they don't have the money to do it and they stay in the workforce longer, does that add to the unemployment problem because the jobs they keep aren't available to other people who need jobs?
Dr. BAKER: Well, there certainly can be a short-term issue. Now, in the longer-term issue, there's no reason why the economy can't create more jobs. But given the situation we're in today where we're looking at an unemployment rate of seven percent and rising very, very rapidly, certainly there will be cases where you could say because the baby boomer - this baby boomer, the baby boomers as a whole, have decided to stay in the workforce longer than they might have otherwise, that's coming at the expense of job opportunities for younger workers. So, I'd see that as a short-term problem.
Over a longer term, assuming we can get the economy back on its feet and somewhere close to full employment, let's say, in, well, three years, four years - hopefully not too far out into the future - then the economy could create jobs to accommodate the baby boomers. That doesn't mean there'll never be a case where you have someone in their 40s who's really upset because there's some guy who's 65 and won't leave, but in principle the jobs will be there.
GROSS: When you look at the economic advisors and President-elect Obama's pick for a Treasury secretary, what kind of pattern do you see emerging about what the economic thinking will be coming from the Obama administration?
Dr. BAKER: Well, certainly his Treasury secretary, Tim Geithner, and Larry Summers would seem to be of the mode that were in the Clinton administration. I mean, they both held top positions in the Clinton administration, and you know, they're both very smart, very competent, qualified people, but nonetheless, they came out of this mode of supporting the sort of deregulation that we had in the Clinton era, thinking that that was the best way for the economy to go forward. So, that does raise serious grounds for concern, at least on my part.
Now, some of the other picks - one of the other picks I'm very, very happy with, Peter Orszag, who's the head of the - or picked as- to be head of the Office of Management and Budget, he had been director of the Congressional Budget Office, very, very good economist, very sharp. I have a great deal of respect for him. So, he was a pick I was very happy with. One of the other picks, Jared Bernstein, who is the chief economist for the vice president, is an old friend of mine, a very - I think, also, a very good economist. So, I think it's somewhat of a mixed bag, but I am certainly concerned about two of the top people being, in essence, holdovers from the Clinton administration, who supported the policies that got us here. So, again, they're both very smart, very competent people. Let's hope they've learned, but it is at least grounds for concern that their history was not - their record is not a good one.
GROSS: Obama has been studying the New Deal, and everybody's weighing in now about the lessons we should learn from the New Deal. Some fiscal conservatives are saying that the lesson from the New Deal we should have learned is that it was too ambitious and that we're still paying the price; there are still programs that were created during the New Deal that we still have to pay for; they've become burdens. Other people are saying that, you know, FDR's problem with the New Deal is that he didn't spend enough. What do you have to say about the lessons we should have learned from the New Deal?
Dr. BAKER: Well, I think I'd very much be in the he-didn't-spend-enough camp. If you look at the history of the New Deal, President Roosevelt comes in 1933 and has a very ambitious program with the Civilian Conservation Corps, Works Progress Administration, other areas where he spent a great deal of money, and it did boost the economy. So, if you look at the economy's growth rate over the years '33, '34, '35, into '36, we're growing double-digit rates over much of that period. So, we had very rapid growth; the unemployment rate came down very rapidly. There's some issue about measurement, but if you count people who are employed in these government programs as being employed, which we would today, the unemployment rate came down from 25 percent when he took office to about 10 percent in 1937.
Now, the big problem that I see was in '37: He cut spending, he had some tax increases and the economy went back into a recession; the unemployment rate went up seven or eight percentage points. He then reversed that in '38, began to spend more, and the economy began to grow. We finally got out of the Depression and got to full employment, over full employment, with the spending associated with World War II and the war itself. We got the unemployment rate down under two percent. But looking back at the picture as a whole, it seems to me, its supports are the simple Keynesian story: You spend lots of money, you create jobs, you create growth, and we ran into problems when he wasn't prepared to spend enough.
GROSS: Well, Dean Baker, thank you so much for talking with us.
Dr. BAKER: Thanks a lot for having me on.
GROSS: Dean Baker is the co-founder and co-director of the Center for Economic and Policy Research and author of the new book, "Plunder and Blunder: The Rise and Fall of the Bubble Economy." Coming up, a skeptical view of Obama's proposed economic stimulus package from Harvard law professor, Greg Mankiw. He chaired President Bush's Council of Economic Advisors. This is Fresh Air.
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