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Nobel Economic Recipe: Help States, Add Stimulus

Peter Diamond, a Massachusetts Institute of Technology economics professor, beams during a Cambridge, Mass., news conference shortly after he won the 2010 Nobel Prize in economics on Oct. 11. (AP)

It's been more than a year since the recession officially ended. The U.S. economy is growing -- albeit slowly -- but high unemployment rates just won't budge. Traditional economic remedies, such as cutting interest rates, aren't making a dent.

Peter Diamond has some ideas on how to break that logjam: a second round of stimulus, and a lot of federal money to keep state and local governments from laying off workers.

And Diamond's got the credentials: Earlier this month, he was one of three co-winners of the Nobel Prize for Economics.

Diamond tells NPR's Guy Raz it's not going to be a quick fix, though.

"Getting unemployment down to a more normal level is going to take a long time, as in at least a couple of years," he says.

The big problem: Not enough businesses are willing to expand and hire workers.

"What's critical is not right now the functioning of the labor market, but the limits on the demand for labor coming from the great caution on the side of both consumers and firms because of the great uncertainty of what's going to happen next."

Looking Local

The first part of Diamond's prescription is another jolt of federal help for state and local governments to keep their workers -- especially police and teachers -- employed.

"The layoffs from state and local government are first of all bad in and of themselves because a lot of what these people do is so valuable. But secondly, when [these people] become unemployed, they spend less and that cuts down the demand."

And Diamond thinks Washington needs to administer another dose of short-term spending, in areas such as construction.

"We've identified a vast amount of need in roads and bridges and tunnels, and we should be pursuing valuable expenditures now at a time when the cost to the economy, the cost to society is a lot less, because a lot of the workers being employed aren't being drawn away from private projects."

Diamond says investing in public works projects is worth the risk of increasing the deficit.

But Are Politicians Listening?

Diamond isn't the only economist calling for more short-term stimulus. In fact, almost every economist Weekend All Things Considered has talked to in the past few weeks echoes that sentiment. But finding common ground with the politicians in Washington and the people on Main Street is another story.

"The first stimulus bill, by all quantitative estimates, produced a huge amount of additional employment," Diamond says. "But that stimulus bill has been extremely unpopular with the American public, even though in the eyes of economists it was a great success."

Economists such as Diamond look at the counterfactual -- what would have happened without the stimulus bill -- and reason that because unemployment would have been much higher, the stimulus bill was a success.

But that's a tough political sell.

Still, Diamond says: "There's so much uncertainty now between the error of doing too little and doing to much. Doing too little seems to me to be much greater risk."

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Transcript

GUY RAZ, host:

We're back with ALL THINGS CONSIDERED from NPR News. I'm Guy Raz.

Almost every weekend on this program for the past few months, we've been asking America's top economists for ideas on how to tackle slow growth and high unemployment. And this past week, we spoke with MIT's Peter Diamond. He's this year's Nobel laureate in economics. And he won based in part on his research into why unemployment stays high for long periods during economic downturns. And here's what he says is happening at the moment.

Professor PETER DIAMOND (Economics, Massachusetts Institute of Technology; Nobel Laureate in Economics): Well, first of all, we don't have enough aggregate demand. We don't have enough opportunity for sales, for businesses to want to expand and hire workers. And people think of unemployment often relative to a simple model: There are jobs. There are workers. Why don't they just match up?

RAZ: Right. Right.

Prof. DIAMOND: But, in fact, the labor market has enormous numbers of flows -millions of workers finding new jobs, losing jobs, firms seeking to hire. It takes a little while to fill a vacancy. And so it's a process that takes time as people look for jobs and...

RAZ: And that's normal. That's what always happens.

Prof. DIAMOND: That's what always happens. What's critical is not right now the functioning of the labor market, but the limits on the demand for labor coming from the caution on the side of both consumers and firms because of the great uncertainty of what's going to happen next.

RAZ: As you know, on this program, we've been canvassing economists from around the country, asking for ideas on how to tackle slow growth and high joblessness. This is your expertise. You have been given the Nobel Prize in the year when your research really is probably more relevant than it's been ever.

You point out that demand for labor is down. What would be the best way to boost that demand?

Prof. DIAMOND: The clearest, simplest way to hold down unemployment is for the federal government to give more money to the states so the states will stop laying off teachers, police, other workers.

The layoffs from state and local government are first of all bad in and of themselves because a lot of what these people do is so valuable. But secondly, when they become unemployed, and they spend less, that cuts down the demand.

And we should be pursuing valuable expenditures now at a time when the cost to the economy, the cost to society, is a lot less because a large fraction of what gets employed will be pulled away from unemployment.

RAZ: So in other words, there has to, you're arguing, some kind of additional stimulus, at least some more short-term government spending, even at the risk of increasing deficits. It just has to be done.

Prof. DIAMOND: Yes. I'm inclined to believe that that's the case. And there's so much uncertainty now. Between the error of doing too little and doing too much, doing too little seems to me to be a much greater risk.

RAZ: Peter Diamond, most of the economists we've spoken to on this program over the past few months, asking them this question, even those who believe in austerity, who say we need to begin to cut, cut, cut, all of them have said, with one exception, that at least in the short term, the federal government has to spend money to stimulate the economy. Why do you think that many, many politicians in Washington don't want to do it?

Prof. DIAMOND: We have the experience of the first stimulus bill, which by all of the quantitative estimates produced a huge amount of additional employment. But that stimulus bill has extremely unpopularity with the American public...

RAZ: Yeah. Right.

Prof. DIAMOND: ...even though in the eyes of economists, overwhelmingly, it was a great success.

RAZ: Because when you guys look at the numbers, you say forget about the politics. Here's what would have happened if it wasn't passed.

Prof. DIAMOND: Well, what we're looking at is the counterfactuals:

RAZ: Right.

Prof. DIAMOND: What would have happened without it? And a counterfactual is not a great political device, as opposed to, hey, we did that, and it didn't work as well as had been projected.

Well, I think it probably did. It's just that the other factors in the economy came out to be considerably worse than were being projected at the time.

So the public looks at what's happening. Things are going badly. We did a stimulus bill. So why should we do another? And the economists say, things would have been a lot worse if we hadn't done the stimulus bill, and that's why we need to do another. And that's a tough political sell.

RAZ: That's Peter Diamond. He's the 2010 Nobel laureate in economics and a professor at MIT.

Peter Diamond, thank you so much.

Prof. DIAMOND: Thank you for having me. Transcript provided by NPR, Copyright NPR.

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