March 9, 2010



WASHINGTON – Council of Economic Advisers Chair Christina Romer warned Tuesday that tightening credit as the economy recovers could choke an economic rebound.

In a speech at the annual policy conference of the National Association for Business Economics, she also said concerns about the budget deficit “would inevitably nip the nascent economic recovery in the bud.”

She defended and promoted the Administration’s programs to jumpstart the economy but reserved her harshest warning for monetary policy set by the Federal Reserve.

“There is a substantial correlation between lending growth and GDP growth,” she said. “Studies that try to disentangle whether it is lending causing GDP, GDP causing lending, or some third factor causing both, find an important causal role for lending. In a paper David Romer and I wrote some years ago, we looked at episodes when the Federal Reserve intervened directly in credit markets to restrain lending, such as its imposition of credit controls in 1980. We found that within about nine months of such an intervention, industrial production had fallen about five percent below its prior path.”

She said the economy had grown as a result of the American Reinvestment and Recovery Act – which she described as “the largest countercyclical fiscal policy action in American history” signed in February 2009. She acknowledged that although Gross Domestic Product has gone from negative 6% in the first quarter of 2009 to positive 5.9% in the last quarter of the year, “we have yet to see GDP growth translate into employment growth.”

However, she said “the most basic evidence that the Recovery Act and the other measures taken to heal the economy have been effective is that the trajectory of the economy has changed fundamentally.”

While employment has not improved, she added, “productivity has grown at roughly a 7% annual rate for each of the last three quarters, the largest rise in productivity over three quarters in more than 50 years.”

She added that “the recent jobs report did contain signs that employment growth could commence in the next few months” but she noted “virtually no one is predicting the kind of strong rebound that would fill the employment gap quickly.”

The new jobs bill passed in different versions by the House and Senate would give firms a fixed amount for each additional worker hired in 2010 and an extra credit for some fraction of the increase in their payrolls, Romer said.

“At its most basic level, a hiring tax credit follows the core economic principle that if you want to increase the consumption of something, lower its price. Of course, when one lowers the price of something to attract extra consumers, some people who would have purchased the good at the old price get the benefit.”

She pointed to a hiring tax credit more than 30 years ago to suggest the legislation would add jobs.

“Such a hiring tax credit has been tried on a large scale in this country only once before — with the New Jobs Tax Credit of 1977 and 1978,” Romer said. “The few available studies suggest that it did have beneficial effects. And private nonfarm payroll employment did increase more than 11% from December 1976 to December 1978, the fastest 24-month growth in the six decades since the Korean War.”

The 1977-78 tax credit would have been more effective, she said, if more companies knew about it.
Romer suggested that like the cash-for-clunkers program and first-time home-buyer tax credit, the jobs tax credit might pull hiring forward.

“The effects of a hiring credit may be particularly large in the current situation,” she said, “because the economy is growing again, most firms are surely planning to hire in the next year or two, as demand for their products increases. In this situation, firms may be particularly responsive to a hiring tax incentive. Because of the reduced cost of employment, they may bring hiring forward to start gearing up for future production and to get the best workers.”

Romer agreed with concerns about the growing budget deficit, but said further spending is necessary to address the economy. “It would be penny-wise but pound-foolish to deal with our long-run problem by tightening fiscal policy immediately or foregoing additional emergency spending to reduce unemployment. Immediate fiscal contraction would inevitably nip the nascent economic recovery in the bud, just as fiscal and monetary contraction in 1936 and 1937 led to a second severe recession before the recovery from the Great Depression was complete.”