Stimulus Worked

• Author: Alan S. Blinder and Mark Zandi
• Position: a Professor of Economics at Princeton University and is Head of Moody's Analytics.

THE U.S. economy has come a long way since the dark days of the Great

Recession. Less than two years ago, the global financial system was on the

brink of collapse, and the United States was suffering its worst economic

downturn since the 1930s. At its worst, real gross domestic product (GDP)

appeared to be in free fall, declining at nearly a 7 percent annual rate, with

job losses averaging close to 750,000 a month. Today, the financial system is

operating much more normally, real GDP has grown by more than 3 percent during

the past year, and job growth has resumed, although at an insufficient pace.

From the perspective, say, of early 2009, this rapid turnabout was a surprise. Maybe the country and

the world were just lucky. But we take another view: the Great Recession in the

United States gave way to recovery as quickly as it did largely because of the

unprecedented responses by monetary and fiscal policymakers.

The Federal Reserve (Fed), the Bush and Obama administrations, and the U.S. Congress

pursued the most aggressive and multifaceted fiscal and monetary policy

responses in history. While the effectiveness and/or wisdom of any individual

element can be debated, we estimate that if policymakers had not reacted as

aggressively or as quickly as they did, the financial system might still be

unsettled, the economy might still be shrinking, and the costs to U.S.

taxpayers would have been vastly greater.

That said, almost every policy response remains controversial, with critics accusing them

of being misguided, ineffective, or both. Resolution of this issue is crucial

because, with the durability of the economic recovery still uncertain, there

may be need for further stimulus.

Policy responses

Broadly speaking, the U.S. government set out to accomplish two goals:

to stabilize the sickly financial system and to mitigate the burgeoning

recession and restart economic growth. The first task was necessitated by the

financial crisis, which struck in mid-2007 and spiraled into a financial panic

in late 2008. After the bankruptcy of the investment banking firm Lehman

Brothers, liquidity evaporated, credit spreads ballooned, stock prices fell

sharply, and a string of major financial institutions failed. The second task

was required because of the devastating effects of the financial crisis on the

real economy, which began to contract at an alarming rate after the Lehman collapse.

The Fed took a number of extraordinary steps to quell the financial panic. In late 2007, it

established the first of what would eventually become an alphabet soup of new

credit facilities designed to provide liquidity to financial institutions and

markets. The Fed lowered interest rates aggressively during 2008, adopting a

near-zero interest rate policy by year’s end. It also engaged in

massive quantitative easing to bring down long-term interest rates, purchasing

treasury bonds and Fannie Mae and Freddie Mac mortgage-backed securities in

2009 and 2010. The Federal Deposit Insurance Corporation increased deposit

insurance limits and guaranteed bank debt. Congress established the Troubled Asset Relief Program (TARP) in October 2008, part of which was used by the U.S. Treasury to inject much-needed capital into the nation’s banks. The

Treasury and the Fed ordered 19 large financial institutions to conduct

comprehensive stress tests in early 2009 to determine whether they had

sufficient capital—and to raise more if necessary. The stress tests

and subsequent capital raising seemed to restore confidence in the banking

system.

The fiscal (that is, taxing and spending) efforts to end the recession and jump-start the

recovery were built around a series of stimulus measures. Income tax rebate

checks were mailed to households in early 2008; the American Recovery and

Reinvestment Act (ARRA) was passed in early 2009; and several smaller stimulus

measures became law in late 2009 and early 2010—such as the Cash-for-Clunkers

tax incentive for auto purchases, the extension and expansion of the housing

tax credit through mid-2010, the passage of a new jobs tax credit through

year-end 2010, and several extensions of emergency unemployment insurance

benefits. In all...