Zandi: Financial rescue and stimulus responsible for saving or creating 8.5 million jobs

Here's your big thought of the day: George W. Bush and Barack Obama did a pretty good job stabilizing the economy and kickstarting recovery after the financial crisis began. That, at least, is the conclusion of a paper (pdf) written by Moody's chief economist Mark Zandi and Princeton's Alan Blinder. They estimate that without the financial interventions and the stimulus, "GDP in 2010 would be about 6½% lower, payroll employment would be less by some 8½ million jobs, and the nation would now be experiencing deflation." I spoke to mark Zandi this afternoon. An edited transcript of our conversation follows.

Ezra Klein: This paper is heavily based on the model you use for economic forecasting. But these models have come under some criticism: Some say that they’re just abstract equations and you can get whatever answer you want by tweaking the numbers. So what is this thing? Who uses it?

Mark Zandi: I developed the model almost 20 years ago. I’m an economic consultant. I’ve got clients in many large, private-sector institutions. And we provide macroeconomic forecasts for them. In more recent years, the model has expanded out. We’ve been doing a lot of scenario analysis. The model has been used by banks to stress test themselves. Bank of America, JP Morgan, SunTrust and others used it to run scenarios on their solvency under different conditions. The business community has come to the realization that the economy matters a lot, and they’re using it to figure out how to account for macroeconomic changes in their own budgeting and planning.

And what are its component parts?

Broadly speaking, there’s a demand side and a supply side. On the demand side, there’s consumer spending, business investment, trade, government spending. Changes in demand are very important for short-term movement in the economy. On the supply side, there’s growth, business stock, demographic trends like immigration and household formation, productivity in the labor supply, and more. The supply side is particularly in the longer-run.

The link between the demand and supply side runs through prices and wages and other costs. If demand falls relative to the economy’s potential, you have rising unemployment and lower utilization. Fiscal and monetary policy plays a key role in trying to mitigate recessions. I’ve gone back to every recession and depression and looked at the policy efforts to address the downturn and try to at least capture the different ways in which policymakers have tried to generate a recovery. And what we’ve done in the Great Recession, some of it is unique, but most of it has been done many times before. Tax cuts, emergency unemployment benefits, aid to state government, these are things we’ve done every single time.

Your paper, based on a model using those historical inputs, says that our response this time has been basically, if not totally, successful.

Any individual aspect could’ve been a failure, or not very effective. But the totality was successful. It ended the recession much sooner than otherwise would’ve been the case and it forestalled a much larger decline in our output. And at the end of the day, it saved taxpayers money. it would’ve cost us a lot more if we had not responded.

Your results suggest that the financial rescue was, if anything, even more significant than the stimulus. It’s since become wildly unpopular, but you’re saying that George W. Bush and Hank Paulson deserve some credit for the policies they created in the immediate response to the crisis.

Absolutely! I think TARP was incredibly important. The mistake was for Congress to vote it down initially. That eviscerated confidence and took the equity market down to a whole other level and exacerbated our problems. By that time, the damage was so serious that the intent of TARP had to shift. Originally, it was about buying bad assets, which would’ve been more graceful. But because of the no vote and the damage it did, they had to make TARP a source of capital for the financial system. The capital purchase program was ultimately the one key thing that was necessary for stabilizing the financial system and the economy.

But it’s also been horribly unpopular, as people feel that the bankers got a free ride. The stimulus is also unpopular. People look at the economy and wonder how 10 percent unemployment can possibly be considered a success.

That’s why I wrote this paper. I think there’s a very significant misconception with regard to TARP and the stimulus, and I wouldn’t have written the paper if I didn’t worry it could have significant policy consequences next time we go through a major recession. Our future responses will be fashioned by how well we perceive how we did during this period. I firmly believe it’s a mistake to say stimulus was not effective.

What are the downside lessons of the response to the crisis? What didn’t we do well?

Before I answer that question, it’s hard to be critical because these things had to be done very quickly, and to gain support to get them done, some things were added into the mix that you would not have done if you were king. One mistake was conflating the near-term stimulus with an infrastructure plan. The infrastructure part was not really stimulus. That’s different than saying whether it’s good or bad policy. The funding for the National Institute of Health, for instance, gets people’s focus, even though it’s pretty minor in terms of the dollars and cents involved. But conflating the two things scrambled the meaning of stimulus in people’s minds.

There were also some marketing mistakes. The original forecast was just a bad forecast. The unemployment rate was already at 8 percent by the time stimulus passed. We just didn’t know it because the data lags. What really matters is what the unemployment rate would’ve been if we didn’t do stimulus, and in my view, it would clearly have been higher.

If the response to the crisis was effective, then why do we seem to have stalled out in recent months? Since May, the recovery has been lagging, hiring hasn’t been very strong, and there’s a general sense that the economic momentum we saw earlier in the year has dissipated a bit.

My view is that the recovery is fragile. Businesses are still very nervous. They have a lot of cash. Their profits are up. But they’re not willing to invest it right now. There’s a lot of speculation as to why. I think policy uncertainty has to be playing a role. And don’t forget, a lot of these companies were near death 18 months ago, and senior managers don’t forget that easily.

Let me ask you about policy uncertainty. I’ve had trouble understanding this case. If the economy was fine and we’d passed the health care and financial reform laws, it’s hard for me to believe we’d be having a major unemployment problem. Conversely, if the economy was exactly where it is but we hadn’t passed those laws, would things really be that different?

I think there’s a great deal of uncertainty with respect to the rules of business and the cost. Health care, regulatory reform, cap-and-trade, immigration policy, and tax policy. Each of those debates have enormous implications for how a business operates and whether they invest and expand. Business people won’t cut payrolls because of it, but they’ll be slow to hire. They just can’t plan. So I think we had to do financial regulation and at the end of the day it addressed some important issues, but it does throw into question some of the rules of the game, and so the banks are trying to figure things out. And they’re also waiting for the regulations from Basel III. So they don’t know how much capital they’ll need. For a bank, that’s their business, so they won’t lend while they’re still figuring it out.

So what do we do now?

The dynamic that’s key to expansion is not fully engaged. In a normal recession, if the unemployment rate was peaking at 7 percent, I’d say no worries, no need for more stimulus. But I’m nervous in the context of 9.5 percent unemployment when you have a zero percent interest rate and a huge deficit. If we’re all wrong and we go into recession, we’ve got no policy response. The Federal Reserve isn’t very effective at this point. Our budget deficit will balloon. So I think it’s prudent to err on the side of doing too much rather than too little. And we can do that. We’re not Greece or the U.K. or Germany. We have a 3 percent 10-year Treasury yield. We have always solved our fiscal problems and the world has faith we will solve our future ones. So we have the resources.