Fighting the last (economic) war
Did you know that not even 50 years ago, New York City was on the verge of bankruptcy?
I don't mean "on the verge of bankruptcy" the way you're used to hearing it from talking heads on CNBC, meaning that a government spent a dollar somewhere. I mean, the city didn't have funds to cover a payment due that day, talks with creditors had fallen through, and default was widely reported as a fait accompli, until a last-minute deal saved the day.
That seems like something I should have known, but I didn't until coming across Kim Phillips-Fein's Fear City: New York's Fiscal Crisis and the Rise of Austerity Politics. Though it's entirely about events in the 1970s, it's perhaps the most important book I've read for understanding the politics of the Obama era.
For one thing, as someone who came of political age in the early 2010s, I thought everything must be new and unprecedented. But bailouts, austerity, free college, disparate treatment of minority neighborhoods, private business leaders pulling strings behind the scenes, and even young protestors "occupying" public buildings were hot-button issues in New York's fiscal crisis a generation earlier.
More importantly, I can better understand the mindset of policymakers who had lived through debt crises and didn't want to repeat them. For all the similarities, the post-Great-Recession era had a few big differences that required new solutions, yet politicians still chased old ghosts of the 1970s. And now that we've moved into a new decade with new challenges, we're in danger of winning the last war again.
No money, mo' problems
How did New York get to the brink of default? The city quadrupled its budget in the 1960s, supported by grants from Lyndon Johnson's Great Society initiatives. But by the 1970s, city revenue was falling short: the Nixon administration reduced federal support; two recessions and high inflation hurt the economy, and upper-middle-income taxpayers were fleeing to the suburbs.
State rules prohibited raising taxes (and it would have accelerated suburban flight anyway), but the new benefits were popular, so NYC borrowed money to cover its budget gap. It expected banks to keep lending money out of civic obligation—as you may have heard, New York has a few banks—but that relationship frayed by the mid-70s: the poor economy made banks more profit-sensitive, and nascent globalization gave them more investment opportunities and fewer community ties.
(The first domino to fall is not historically important, but it's a fun butterfly-effect story: early in 1975, New York did a routine debt sale, but the leading bank's head of municipal bond purchasing got sick and someone from another department stepped in. He ran the deal by lawyers—standard practice on most deals but apparently not in munis—who found something they didn't like and scuttled the deal. One person's illness didn't cause New York's near-bankruptcy, but it probably accelerated it.)
The city finally cut spending in 1975: it laid off tens of thousands of workers, not only in welfare services but in sanitation, firefighting, and police. (After the latter, laid-off policemen took over the Brooklyn Bridge for hours.) It created a public-private consortium that had power to make more budget cuts directly, but they weren't enough to balance the books. And it asked Washington to lend it money, but the now-Ford administration refused because a "bailout" would set a bad precedent—leading to a famous Daily News headline: "Ford to City: Drop Dead".
Debt issuances became increasingly fraught until one day in October, when the New York teachers' union surprisingly voted down its share of a purchase that the city needed to cover a payment due at midnight. A bankruptcy press release was written and news stations reported that a default was imminent, until a late deal got the union to reconsider.
How did New York come back from that brink? According to Phillips-Fein, the conventional narrative is "all sides came together to make sacrifices"—but in reality, she says, neoliberalism won and the New Deal ideology lost. The city gave even more control of its budget to an oversight board led by business leaders, laid off 70,000 more workers, defunded CUNY's free tuition program, and gave companies tax incentives to come back from the suburbs. Regardless of which narrative you believe, the common thrust is that too much debt caused a crisis, and solving it required sacrifices.
Macroeconomics peaked when you were a teenager
Fast-forward to another crisis: the Great Recession in 2007-09. It was really bad: unemployment rose and consumer spending fell by the most in 70 years.
In a recession, the federal government can help boost the economy by spending more and/or lowering taxes, and the US did some of that early on. But if you keep doing that indefinitely, you have to issue more and more debt, which might lead to default like New York almost experienced. (You also risk inflation, which we'll come back to later.) So the political discussion in the 2010s quickly moved on to "austerity": how to balance the budget. This wasn't just Tea Party whining; the Obama administration also wanted to reduce the deficit. They just disagreed about whether spending cuts or tax increases were the way to do so.
Even after the worst of the recession, the economic recovery was notably slow compared to prior recessions, in part due to austerity. If austerity had actually prevented a debt or inflation crisis, that would have been a fine trade-off. But a crisis was nowhere in sight—not only in retrospect, but for indicators available at the time:
People worried about runaway inflation, but actual inflation was persistently below where it's supposed to be.
And people worried about a debt crisis, but interest rates were historically low, meaning investors wanted to lend the US government even more money than it was taking.
Policymakers thought those problems were coming, but they were wrong. And that's probably due to the shadow of the 70s.
Thanks to the Boomer Blockade, most financial and political leaders of the Great Recession era began their professional careers in the 1970s. That's a time when US economy was truly imperiled by high inflation (peaking at more than 10% per year), and when the NYC debt crisis and others like it were in the news regularly.
Survey evidence indicates that your inflation expectations and investing behavior are shaped by what happened when you entered adulthood. You might think that the world's leading economists are immune from this phenomenon, but it turns out there's evidence for it among Federal Reserve leaders too. So it's natural, if unfortunate, that policymakers around the world were too scared of debt and inflation crises to stimulate the economy appropriately.
The dawning of the age of Millennials
Today there's a new wave of economic policymakers in power, partly due to the last generation's failures and partly due to demographics. Too young to remember the 70s, today's leaders were instead shaped by the Great Recession experience: deficits are overrated, and more spending is better. You can see this kind of thinking both on the left (Green New Deal/Build Back Better-type programs come with huge price tags) and right (Trump's proposed tax cuts far outweigh his spending cuts).
This worked out great in 2020, when an even steeper economic crisis hit with COVID-19; the US government spent more on stimulus than any other major country and had the fastest recovery.
But today, and seemingly for the near future, the economic environment is different: interest rates are high, and inflation is decreasing but still higher than it should be. That's a world in which austerity would actually be helpful, and yet there seems to be little appetite for it.
To be clear, a NYC-level crisis is absolutely nowhere in sight for the federal government, and it almost certainly will never be. But I do think the culture of worshipping stimulus and ignoring deficits is likely to be entrenched going forward. If the environment has in fact changed, and different solutions are needed, policymakers will probably be behind the curve once again.
