Time to bury the Clinton economic legacy

At the moment, no prominent politician in national politics is arguing the case for a government budget that could bring the economy anywhere near to full employment. This is tragic, since we are still down more than 8 million jobs from the economy’s prerecession growth path. Even if we sustained the relatively strong job growth of November, we would not return to full employment until 2020.

It is perhaps understandable that we don’t hear Republicans pushing for a budget to get the economy to full employment, but it should be surprising that even Democrats don’t push such an agenda. Much of the reason stems from a misreading of Bill Clinton–era economic policy and the tendency by those in top positions in the Democratic Party to perpetuate this misreading.

The story told by Democrats is that Clinton took the tough steps to bring down the budget deficit and balance the budget. He raised taxes and cut spending, even at the risk of alienating his base. The move toward a balanced budget caused the economy to boom, giving us the low unemployment and budget surpluses of the late 1990s. 

In this story, everything went haywire when George W. Bush arrived in the White House and squandered the surplus with his big tax cuts. Making matters worse, he fought the wars in Afghanistan and Iraq without paying for them. The wars and tax cuts shifted the budget from large surpluses to large deficits, resulting in slower growth and eventually the financial crisis in 2008.

This story is fundamentally wrong, starting with the most basic point: The tax increases and spending cuts put in place by Clinton would not have balanced the budget, much less led to a large surplus. The Congressional Budget Office’s 1996 projections for the year 2000, still showed a deficit in 2000 equal to 2.5 percent of GDP ($400 billion in today’s economy). These projections were made after all the Clinton-era tax increases and spending cuts were passed into law.  

The reason we had a surplus of 2.5 percent of GDP in 2000 instead of a deficit was that the economy was propelled by a stock bubble. The bubble led to a boom in consumption, which caused the saving rate to hit a record low. There was also a surge in investment as overhyped dotcom companies were able to raise billions on the stock market even if it was entirely unclear how exactly they could make a profit.

Since the growth was driven by a bubble, after the bubble burst, the economy fell into recession from 2000 to 2002. Fortunately for the Clinton legacy, Bush was sitting in the White House when the effect of the market plunge hit the economy. While Clintonites like former Treasury Secretary Robert Rubin and National Economic Council Director Gene Sperling condemn the tax cuts and unfunded wars as “blowing a hole in the budget,” in reality they provided much-needed stimulus to an economy that did not regain the jobs lost in the recession until January 2005.

While tax cuts for the rich and wars are inefficient ways to provide stimulus (and horrible policy if the wars are not necessary), larger deficits were exactly what was needed to boost the economy. The Fed was pretty much up against the zero lower bound — the point at which it cannot lower interests rates any further to stimulate the economy — with the federal funds rate at 1 percent from the summer of 2002 until the summer of 2004. This meant that there was little the Fed could have done in the form of conventional monetary policy to boost the economy had the government run smaller deficits.

If the dollar had been lower, it could have contained our ballooning trade deficit, but that would have required reversing another legacy of the Clinton era, the strong dollar. As a simple matter of accounting, there was no alternative to large deficits to bring the economy back to full employment, with the exception of another bubble.

There were certainly much better ways to generate jobs than the route chosen by Bush, but the problem was the use of the deficits, not the size of the deficits. However, the Clintonites chose to harp on the budget deficits as the root of all economic evil. For example, in an op-ed in May 2005 titled “Attention: Deficit disorder,” Rubin pronounced the budget deficit the “most pressing” problem facing the country. This was when the housing frenzy was reaching its peak.

This pattern persisted even after the collapse of the housing bubble put the economy in a situation similar to but far worse than the situation faced by Bush in 2001. Honesty would have required saying that until a lower dollar brought the trade deficit close to balance, it would be necessary to run large budget deficits to sustain demand. However, this would have meant disavowing the Clinton legacy.

That poses a problem, since so many of the top figures in Democratic circles have their service in the Clinton administration as the lead item on their resumes. They want to preserve the fiction that the prosperity of the late 1990s was due to deficit reduction rather than an unsustainable stock bubble.

As a result, there are few people with prominence in the national debate who are prepared to be honest about the economy. Needless to say, Republicans are not eager to acknowledge that larger budget deficits are necessary to boost demand. With top Democrats clinging to their fantasy of the Clinton glory days, we won’t hear talk about the need for larger deficits from them either.     

Politicians love to repeat the canard that families have to eventually balance their budgets, therefore governments must also. This assertion makes about as much sense as claiming that the earth is flat because we can see the ground in front of us is level. Both are obviously wrong, but until the Democrats are prepared to reject the Clinton legacy on budget policy, we will be condemned to live in a world of flat-earth economics.