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The Answer to Our Economic Problems: Changing Fiscal Policy

It is no secret that the economic environment in the United States is in the doldrums. Market forces are global. Indeed, globalization has a large impact on institutions. It has less of an impact on the average American. Joe Six Pack is affected more by U.S. fiscal policy than monetary policy.  Government urgently needs to change fiscal policy to help Joe. Since so many nations have tied their fortunes to the U.S. horse, lots of wagons will be lifted up by changes.

In any survey of economists, economic or financial blogs, or market analysts, the news is not pretty. Unemployment is very high.  Some are trying to rationalize this as a “new normal,” departing from the traditional “frictional unemployment” standard of 4-5% as a benchmark. During the Clinton years, unemployment dropped to 4%, and at the time many pundits were hailing the “new economy” as an economic environment where everyone would have access to a job. The reality is that 4% unemployment is not a realistic rate, and today’s +9% isn’t either. The 5% frictional unemployment rate as postulated by economists long ago is still the best standard to define success or failure.

Since the advent of the crisis in August 2007, the Federal Reserve and U.S. Treasury Department have engaged in extraordinary machinations of monetary policy to try and stem the crisis. We have had new lending facilities, expansion of what the Fed takes as collateral, easy money, 0% interest rates, quantitative ease, TARP, TALF, incredible cooperation with other central bankers, and constant jawboning that things will be okay. Other agencies like the FDIC have been increasingly accommodative. These are extraordinary circumstances, and to combat them, we need creative and extraordinary policy.

We have reached the end of the road for monetary policy.

Government spending will not cause the economy to rebound. The Obama administration has spent more than any other administration in our nation's history. Unemployment has risen during this spending spree. The multiplier effect of government spending is close to 0. The multiplier effect of tax moves is close to 3. This means that for every percentage decrease in a tax, there is a three percentage move in corresponding economic activity. Moving tax rates lower is the way to lift the country out of recession.

One needs a Rosetta Stone to read and understand the U.S. tax code. It will take years to reform the tax code to make it simpler and economically efficient. There are way too many sacred cows and politicians to move quickly. America doesn’t have that kind of time. There are a few simple taxes that the government can change to increase the chances that jobs are created and sustained growth can begin again.