The Rule Obama Forgot: “It’s the Economy, Stupid.”

The Rule Obama Forgot: “It’s the Economy, Stupid.”


While the poor state of the economy was undoubtedly the primary reason for big Democratic losses in Tuesday’s elections, it is also clear that those losses were a referendum on Barack Obama’s administration. I believe his critical error was that he didn’t give unemployment and the sluggish economy the attention they deserved. Every election is fundamentally about pocketbook issues, and Obama and Democrats in Congress appeared to take their eye off the ball and suffered more than they had to as a consequence.

The first and most important mistake Obama made was to misjudge the depth of the economic crisis he faced when taking office in January 2009. “The truth is, there was a misreading of just how bad an economy we inherited,” Vice President Joe Biden admitted in a July interview. This led to an underestimation of the magnitude of the response that was necessary.

It’s important to remember that the recession began during the George W. Bush administration in December 2007 from policies pursued during his administration – it didn’t suddenly begin on January 20, 2009, as many Republicans implicitly believe. One major round of fiscal stimulus in the form of a $117 billion tax rebate in early 2008 had already been expended without having much effect in slowing the economic descent. An additional $61 billion stimulus measure that passed in the House was defeated by Senate Republicans in September 2008, and they also killed another effort after the election that delayed effective stimulus for several months while the economy deteriorated.

Perhaps if Bush had proposed a more effective stimulus (a previous tax rebate in 2001 utterly failed to stimulate growth, but he proposed another one anyway because tax cuts are the only form of stimulus Republicans will support) or if Republicans had not torpedoed further efforts at a critical moment, then perhaps the economy’s downward momentum wouldn’t have been quite so severe when Obama took office. But after the failure of Lehman Brothers in September 2008, it was clear that the economy was in free fall. Consequently, it was going to take much more effort to turn the economy around than it would just a few months earlier.

Obama’s economic advisers have admitted their error in forecasting the severity of the economic downturn. A memo by then-Council of Economic Advisers chair Christina Romer and Jared Bernstein of Biden’s staff estimated that the unemployment rate would not rise above 9 percent even with no stimulus; it peaked at 10.1 percent a year ago and was 9.6 percent in September.

But even with the underestimation of the downturn, Romer still thought that $1.2 trillion of fiscal stimulus was needed, according to a report by Ryan Lizza in The New Yorker, and confirmed by House Appropriations Committee chairman David Obey in an interview with The Fiscal Times. Nevertheless, the administration only asked for $816 billion, which was embodied in H.R. 1 and introduced by Obey on January 26, 2009. It was whittled down a bit in the Senate to get 60 votes and avoid a Republican filibuster, and the final legislation provided for $787 billion of stimulus. It was signed into law on February 17.

Perhaps even more important than the insufficient size of the stimulus package was its composition. In what appears to have been a futile effort to get Republican support, Obama included a very substantial tax cut in his stimulus proposal, which accounted for 27 percent of the cost of the final package. The key element was the Making Work Pay Credit, which reduced the tax payments of everyone with a federal income tax liability and an income below $75,000.

There were two important consequences of Obama’s tax cut, one substantive, the other political. The substantive problem is that there was very little bang-for-the-buck in the tax cut. According to a May 2009 study by the CEA, the impact on the gross domestic product from a tax cut is one third to one half smaller than that from an increase in government purchases. Moreover, because the tax credit mainly affected tax withholding, people didn’t really see it and thus increased their spending even less than they did in response to the 2008 rebate, according to a July paper from the National Bureau of Economic Research.

The political problem is that by offering his tax credit up front, rather than negotiating with Republicans on inclusion of a tax cut in the stimulus package, he lost an opportunity to possibly buy their support. One idea Republicans were keen on, that Democrats might have supported, was a temporary cut or suspension of the payroll tax, which could have been more effective in stimulating employment than the tax credit. In the event that Republicans refused to negotiate, the money consumed by the tax cut could have been reprogrammed into more economically effective public works.

Once the stimulus package was enacted, I think Obama erred by quickly turning his attention elsewhere – toward health care reform, energy and environmental issues, financial regulation and others. I think he should have focused like a laser on the economy until it was clear that it had turned the corner. Economist Paul Krugman, among others, has ridiculed this idea on the grounds that additional stimulus was politically impossible and there was really nothing Obama could do except wait for the stimulus that was enacted to work.

I think this is wrong, again for both political and substantive reasons. The political problem is that Obama appeared indifferent to the Number One problem affecting people over the last two years – unemployment. It’s not just that people want the president to feel their pain. If Obama had made jobs more of an issue, it might have changed the political dynamics by making the unemployed a more significant political force and made it easier to pass an extension of unemployment compensation and additional stimulus measures.

It has amazed me since the beginning of the recession that the many millions of those unemployed seem to have accepted their fate so meekly. I don’t know why this is the case. Perhaps it’s because they have been browbeaten into accepting the right-wing idea that they are just lazy and could find a job if they really wanted to, or maybe they have given up hope of ever finding a job and taken early retirement, or perhaps a still-working spouse has kept the family adequately afloat.

I think that a major factor is the decline of labor unions in the U.S., especially those in the private sector, because they tend to be the organizers of political pressure related to jobs. Another factor may be that so many of those that are still union members are now in the public sector, where they have different political priorities, such as protecting their own jobs, pay and benefits from cuts forced by sharply-declining state and local government revenues.

Substantively, I think there was more that could have been done to stimulate growth that might have been doable if Obama had been more engaged in the problem. For example, all economists know that monetary policy is critical to restoring growth. Yet Obama allowed vacancies on the Federal Reserve Board to be unfilled for months and then did nothing to get his appointees confirmed in the Senate. Amazingly, one of his appointees, economist Peter Diamond of MIT, has been blocked by Senate Republicans on the grounds that he is not a good enough economist. On October 11, he was awarded the Nobel Prize in economics.

A fully staffed Federal Reserve Board is essential for monetary policy to aggressively combat unemployment because its key policymaking arm is the Federal Open Market Committee, which consists of the seven board members plus five regional bank presidents. Historically, the bank presidents have been more conservative than the board members and tend to be very fearful of inflation, no matter how little there is, and less concerned about unemployment and slow growth.

If Obama had been out there every day talking about the economy, pressuring Congress and cabinet agencies to be more active, and paying closer attention to the progress of the stimulus, then I think the political dynamics might have been quite different. It’s likely that further stimulus, which has appeared to be politically impossible, might have been achievable. At least Obama could have been more engaged in the extension of expiring tax cuts, which threaten a significant fiscal contraction on January 1 unless Congress acts quickly.

Political scientists are virtually unanimous in their view that economic conditions exercise an overwhelming influence on national election outcomes. Consequently, they believe Democrats were doomed to suffer heavy losses no matter what they did. But I believe their losses were greater than they would have been if Obama had been more focused on the economy. At a minimum, it would have helped energize the Democratic base, much of which stayed home on Tuesday according to exit polls. Obama needs to act now to make sure the same thing doesn’t happen on Election Day, 2012.