Restoring Fiscal and Monetary Policy

It has been three years since the financial crisis flared up and the recession began.  Yet the unemployment rate is still over 9 percent -- double what it was before the recession -- and it has been stuck there for 20 consecutive months.  Why the extraordinarily high and prolonged unemployment?  Discretionary government interventions -- deviations from sound economic principles and policies -- have been largely responsible, says John B. Taylor, a professor of economics at Stanford University and a senior fellow at the Hoover Institution.

At best, actions like the stimulus and cash for clunkers had a small temporary effect that dissipated quickly, leaving a legacy of higher debt, a bloated Fed balance sheet and uncertainty -- all of which slow growth and job creation.  The best way to reduce unemployment is to restore sound fiscal and monetary policies.

• The government should start by laying out a credible plan to reduce spending and stop the debt explosion.

• If spending as a share of gross domestic product (GDP) can be brought to 2000 levels and held there with entitlement reforms, then the budget can be balanced without employment-retarding tax-rate increases.
• A concrete goal should be to establish a long-term budget that the Congressional Budget Office (CBO) can credibly show would bring the debt-to-GDP ratio to 40 percent.
• If the plan is ready for this summer's CBO long-term projections, it will give an immediate boost to economic growth and job creation as uncertainty about debt sustainability falls.

Source:  John B. Taylor, "A Two-Track Plan to Restore Growth," Wall Street Journal, January 28, 2011.

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