1. Fiscal Policy: Austerity vs. Stimulus Jeffrey Frankel Harpel Professor of Capital Formation and Growth Senior Executive Fellows, October 21, 2013

2. Definitions Fiscal austerity (“contraction”) : –Cut government spending / raise taxes, –raising budget surplus (or reducing budget deficit), to avoid economic overheating & strengthen long-run debt sustainability. (Deficit = Δ debt). Fiscal stimulus (“expansion”): –Raise government spending / cut taxes –to provide short-term economic stimulus, for growth & employment. Austerity vs. Stimulus

3. “What is the best fiscal policy, Austerity or Stimulus?” The question is as foolish as to ask, “Should a driver turn left or right?” It depends where he is in the road. –Sometimes left is the answer, sometimes right. Austerity vs. Stimulus, continued

4. Cyclicality of Fiscal Policy Keynes favored counter-cyclical policy: –fiscal stimulus when under conditions like the 1930s -- depressed income, high unemployment, low inflation, low interest rates – to moderate the downturn, –but fiscal contraction during boom periods, to prevent over-heating. The boom, not the slump, is the right time for austerity at the Treasury.” - John Maynard Keynes (1937) Collected Writings

5. Keynesian policy (“fine tuning”) fell into disfavor in part because it was hard to get the timing right: By the time fiscal stimulus became law, the recession would be over, e.g., the Kennedy tax cut, passed in1964. But that is no excuse for pro-cyclical fiscal policy. Definition of pro-cyclical fiscal policy: Governments raise spending (or cut taxes) in booms; and are then forced to retrench in downturns, thereby exacerbating upswings & downswings.

6. Central message of this talk: During the decade after 2000, some Emerging Market governments learned how to do counter-cyclical fiscal policy, while many Advanced Country politicians forgot, turning pro-cyclical instead, exacerbating the business cycle.

7. Cyclicality of Fiscal Policy, continued Conspicuously, Greece & other euro members failed to reduce budget deficits during years of growth, 2002-08 –and were then forced to cut spending & raise taxes during the euro debt crisis of 2010-12, exacerbating the recession, & even raising Debt/GDP. But the United Kingdom did the same, –despite no euro-constraint forcing austerity in 2010-13. And so did the United States !

8. Why do leaders fail to take advantage of booms to strengthen the budget? People don’t see the need to “fix the hole in the roof when the sun is shining.” –They do see the mistake when the storm hits, but then it is too late. Official forecasts are over-optimistic in boom periods, rationalizing the failure to act. –according to data from 33 countries.

9. Consider the experiences of Emerging Market / Developing countries Europe How can countries head off temptation for fiscal stimulus in the boom? The fiscal situation in the US Long-term Medium-term Short-term Remainder of this talk

10. Most experience with sovereign debt problems during our lifetimes arose in developing countries Recycling of petrodollars after 1974 - –ended in the international debt crisis of 1982 and the Lost Decade of growth in Latin America. Emerging market inflows in the 1990s –ended in currency crashes: Mexico (1994), East Asia, Russia (1997-98) Turkey, Argentina (2001)…

11. Emerging Market (EM) countries learned from the crises of the 1980s & 1990s. Many EMs took advantage of the 2002-07 expansion to strengthen their budgets along with other reforms, esp. adding to reserves & reducing currency mismatch. They achieved: –Lower debt levels than advanced economies; –improved credit ratings; –lower sovereign spreads; and –less pro-cyclical fiscal policies. Historically, policy in developing countries was pro-cyclical. E.g., the correlation between spending & GDP was positive.

12. 12 Correlations between Gov.t Spending & GDP 1960-1999 procyclical } G always used to be pro-cyclical for most developing countries. countercyclical Adapted from Kaminsky, Reinhart & Vegh (2004) Pro-cyclical spending Counter- cyclical spending

13. 13 Correlations between Government spending & GDP 2000-2009 In the last decade, about 1/3 developing countries switched to countercyclical fiscal policy: Negative correlation of G & GDP. Frankel, Vegh & Vuletin (2012) procyclical countercyclical

14. 14 The historic role reversal Over the last decade some emerging market countries finally developed countercyclical fiscal policies: They took advantage of the boom years 2003-2007 –to run primary budget surpluses and cumulate reserves. –And so were able to respond to global recession of 2008-09. –E.g., Botswana, Chile, China, Korea, & Malaysia. Debt levels among rich countries (debt/GDP ratios > 90%) have reached triple those of emerging markets. Some emerging markets have earned credit ratings higher than some so-called advanced countries.

15. Country creditworthiness is now inter-shuffled “Advanced” countries (Formerly) “Developing” countries AAA Germany, UKSingapore, Hong Kong AA+ US, France AA BelgiumChile AA-JapanChina A+Korea AMalaysia, South Africa A-Brazil, Thailand, Botswana BBB+Ireland, Italy, Spain BBB-IcelandColombia, India BB+Indonesia, Philippines BBPortugalCosta Rica, Jordan BBurkina Faso SD Greece S&P ratings, Feb.2012 updated 8/2012

16. Advanced economies did not. EMs & Developing Countries took advantage of the 2002-07 boom to run budget surpluses. World Economic Outlook, IMF, April 2012 World Economic Outlook, IMF, Oc.2013

17. By 2008, debt/GDP ratios in G7 countries were double those in EM & developing countries. World Economic Outlook, IMF, Oct.2013

18. Since 2008 recession, advanced countries have cut spending, relative to past recoveries; EMs have raised spending (having been relatively more conservative before 2008) World Economic Outlook, IMF, April 2013

19. 19 Source: IMF, 2011. I. Diwan, PED401, Oct. 2011 Greece let its deficit rise during the growth years, 2001-08, despite the 3% of GDP limit set by the Stability & Growth Pact SGP floor & then was forced into sharp austerity in 2010-12.

20. Many leaders in advanced economies ignored the lessons of past crises. They thought debt crises could never happen to them -- most notably, leaders of euroland, –even after the periphery countries violated the deficit & debt ceilings of Maastricht and the SGP; –and even after the Greek crisis hit in late 2009.

21. This Time is Different, updated in “From Financial Crash to Debt Crisis,” 2010 Sovereign External Debt: 1800-2009 Percent of Countries in Default or Restructuring 50%- Note: Sample size includes all countries, out of a total of sixty six, that were independent states in the given year. Sources: Lindert & Morton (1989), Macdonald (2003), Purcell & Kaufman (1993), Reinhart, Rogoff & Savastano (2003), Suter (1992), and Standard & Poor’s (various years). 1980 s 1930 s 1870 s 1830 s But defaults on sovereign debt are on old story, including most industrialized countries at one time another Christophe Trebesch; with data from: Reinhart/Rogoff (2009), Sturzenegger/Zettelmeyer (2006), Meyer/Trebesch (2013) 304 sovereign defaults since 1820 Of these, 154 occurred in Latin America.

22. European Debt/GDP ratios have been rising sharply, as high interest rates & negative growth overpower progress on reduction of primary budget deficits. Via: World Bank, PREM, 2012

23. Fiscal rules have been adopted by many countries. Do they help? Europe’s rules have failed (BD < 3% GDP; Debt < 60% GDP) Maastricht Criteria & Stability & Growth Pact –Angela Merkel’s Fiscal Compact may be no better. Such rules do not work in the US either: –Gramm-Rudman-Hollings in late 1980s –Debt ceiling legislation – Why? Budget balance rules are in fashion.

24. “Tough” rules like the SGP or BBA are too rigid. requiring fiscal contraction when the economy is weak. They also lack enforceability: Every Euro country violated the SGP. They worsen the problem of over-optimistic forecasts. –E.g., when euro members go above the 3% deficit ceiling, they adjust their forecasts, not their policies. Better would be “structural” budget targets (Swiss) with forecasts from independent experts (Chile).

25. Three distinct US fiscal problems The long-term debt problem The medium-term economic problem The short-term political problem

26. Three distinct US fiscal problems The long-term problem -- debt unsustainability –warrants a path back to fiscal discipline. The medium-term economic problem -- slow recovery in aftermath of the 2008 financial crisis, –warrants demand stimulus today, not contraction, which is now holding back growth. The short-term problem is political: –A succession of artificial deadlines, each threatening disaster.

27. Not sustainable The US does have a long-term debt problem.. Fiscal policy Source: Concord Coalition, spring 2013 http://www.concordcoalition.org/issues/indicators/projected-debt

28. The long-term US debt problem, continued “Long-term” in the sense that debt/GDP will rise alarmingly after the 2020s –unless entitlements are put on a sound footing: Social Security & Medicare are due to run big deficits –as the baby-boomers retire (predictably) –and the cost of health care rises rapidly (less predictably). Definition of debt sustainability: –regardless the level of the debt, it is sustainable if the future debt/GDP ratio is forecast to fall indefinitely.

29. There is not a short-term problem: –Far from tiring of absorbing ever-greater levels of US treasury securities, global investors continue happily to lend at record-low interest rates (2008-13): The US enjoys safe-haven status; the $ enjoys “exorbitant privilege.” –There is no fiscal crisis. The US is not Greece, though we want to be sure not to become Greece in 20 years. Indeed the federal budget deficit is now coming down from 9 % of GDP in FY 2009 to 4 % in FY 2013. –despite the continued weakness in the economy. Debt/GDP will come down over 2014-18. Long-term debt problem, continued

30. The budget deficit is currently on a declining path. “The Rapidly Shrinking Federal Deficit” Goldman Sachs Global Economics, Commodities & Strategy Research (Hatzius), Apr.10, 2013

31. Debt / GDP is set to decline over 2014 -18. Center on Budget and Policy Priorities, Jan.9, 2013 http://www.cbpp.org/cms/index.cfm?fa=view&id=3885 CBPP recommends a further $1.2 tr. in spending cuts & tax rises to stabilize debt out to 2022. But there is no need for it to hit this year. That would send us back into recession.

32. The debt problem is also “long-term” in the sense that we have known about it a long time. "For decades we have piled deficit upon deficit, mortgaging our future and our children's future for the temporary convenience of the present… We must act today in order to preserve tomorrow. And let there be no misunderstanding: We are going to begin to act, beginning today.” –Inaugural address, Jan. 20, 1981 Long-term debt problem, continued E.g., when Ronald Reagan, took office:

33. The US public discussion is framed as a battle between conservatives who philosophically believe in strong budgets & small government, and liberals who do not. Democrats, Republicans, & the media all use this language. (1) The right goal should be budgets that allow surpluses in booms and deficits in recession. (2) The correlation between how loudly an American politician proclaims a belief in fiscal conservatism and how likely he is to take genuine policy steps < 0. [1] Never mind that small government is classically supposed to be the aim of “liberals,” in the 19th century definition, not “conservatives.” My point is different: those who call themselves conservatives in practice tend to adopt policies that are the opposite of fiscal conservatism. I call them “illiberal.” “ Republican & Democratic Presidents Have Switched Economic Policies” Milken Inst.Rev. 2003. “ Republican & Democratic Presidents Have Switched Economic Policies”Milken Inst.Rev. It is not the right way to characterize the debate. [ 1]

34. Brief US fiscal history: The 1980s The newly elected Reagan complained of the inherited debt: –“Our national debt is approaching $1 trillion. … A trillion dollars would be a stack of 1,000-$ bills 67 miles high.” address to Congress, Feb. 18, 1981. Reagan’s actions: sharp tax cuts & rise in defense spending. The claim: budget surpluses would result. The reality: record deficits that added to the national debt –a 2 nd trillion in his 1 st term –a 3 rd trillion in his 2 nd term –a 4 th trillion when G.H.W. Bush initially continued the policies. (“Read my lips, no new taxes.”)

35. US fiscal history, continued : The 1990s The deficits were gradually cut, and then converted to surpluses by the end of the 1990s. How was this accomplished? –Regime of “Shared Sacrifice” -- 3 key policy events. 1990: GHW Bush bravely agreed spending caps, taxes & PAYGO 1993: Clinton extended the policy. 1998: As surpluses emerged, “Save Social Security 1st.” –Strong growth in late 1990s.

36. Fiscal history, continued : The 2000s The Shared Sacrifice regime ended on the day G.W. Bush took office in Jan. 2001. He returned to the Reagan policies: –Large tax cuts –together with rapid increase in spending (triple Clinton’s) not just in military spending (esp. Iraq & Afghanistan), but also domestic spending: discretionary + Medicare drugs benefit. Just like Reagan, he claimed budget surpluses would result. Just like Reagan, the result was record deficits: –The national debt doubled. I.e., GWB incurred more debt than his father + Reagan + 39 predecessors

37. Where are we now? The political crisis: repeated partisan standoffs in Congress. To reduce the budget deficit: how far can we get by discretionary spending cuts? Where are the right places to squeeze, politics aside ?

38. Repeated partisan stand-offs in Congress The summer of 2011: Congress refused the usual debt ceiling increase, –recklessly threatening government default. –Political dysfunction led S&P to downgrade US bonds from AAA. 2013: –“Fiscal cliff,” Jan. 1; –Sequestration into effect March 1; –Government shutdown, Oct. 1-16; –Debt ceiling, Oct.17. Next: –Dec.15: Attempt at negotiating a budget. –Jan. 15, 2013: Next shutdown deadline. –Feb. 7: Next debt ceiling deadline.

39. The game of “Chicken” In the 1955 movie Rebel Without a Cause, whoever jumps out of his car first supposedly “loses” the game. James Dean does; but the other guy miscalculates and goes over the cliff.. The Republicans may have miscalculated.

40. How far can we get by cutting spending? Total federal spending = $3 ½ trillion. That spending minus tax revenue leaves a budget deficit of $ ¾ trillion in 2013 down from $1.1 trillion in 2012, and from $1.4 trillion in 2009. Many Republican congressmen have campaigned to cut only non-defense discretionary spending, –to exempt defense & senior-related spending (Soc. Security & Medicare). –And adamantly no tax increase. That was their official platform in the 2010 election. Even if we could set all non-defense discretionary spending =0, it would not eliminate the deficit.

41. 3 biggest spending categories: Health, Social Security, & Defense Medicare & medicaid { Concord Coalition. Data Source: CBO, Jan. 2012 Since 2011, discretionary spending is down (esp. as share of GDP): Defense to 18% of spending, income security to 15%. Entitlements are up: Social Security to 23% of spending & health to 25%. Both will rise rapidly in the future.

42. 12 years ago, if the country thought it important enough to protect any single category against belt-tightening in the long run -- say military or social security or tax cuts for the rich -- it would have been arithmetically possible, by making the cuts elsewhere. But we no longer have the luxury of such choices after the legacy of the last decade — –after the effects of mammoth tax cuts (2001 & 2003), –two wars (2001, 2003), –the Medicare prescription drug benefit (2003), –and the severe financial crisis & recession (2008). Starting from our current position, each of the 5 components must play a role, along with taxes.

43. What steps should be taken today to lock in future fiscal consolidation? –Not by raising taxes or cutting spending today (new recession); –nor by promising to do so in a year or two (not credible). –There are lots of economically sensible proposals for spending to eliminate over time, more efficient taxes to phase in, and “tax expenditures” to phase out. If there were no political constraints…

44. How to reduce the budget deficit The only way to do this is both reduce spending & raise tax revenue, as we did in the 1990s. Spending. Examples:Spending. Examples: –Eliminate agricultural subsidies. –Cut manned space program. –Trim National Guard & Reserves, –Close unwanted military bases –Cut unwanted weapons systems A rare success: the F22 Raptor fighter. Now F-35 Joint Strike Fighter? ($600b/10 yrs.) Global Hawk Block 30 drone program? The C-27J Spartan cargo aircraft? Upgrades to the M1 Abrams tank Virginia-class submarine? ($2.6 b)

45. How to reduce the budget deficit The only way is both reduce spending & raise tax revenue, continued. The only way is both reduce spending & raise tax revenue, continued. Tax revenue optionsTax revenue options –We could have let G.W. Bush’s tax cuts expire in 2013. –Can still curtail expensive & distorting “tax expenditures” E.g., Tax-deductibility of mortgage interest,E.g., Tax-deductibility of mortgage interest, & of health insurance& of health insurance Subsidies to oil industry, low tax rate on carried interest, …Subsidies to oil industry, low tax rate on carried interest, … –Or launch more ambitious tax reform: Introduce a VAT, sales, or consumption taxIntroduce a VAT, sales, or consumption tax or phase in an energy or carbon taxor phase in an energy or carbon tax –or auctioning of tradable emission permits

46. Distortionary subsidies hiding as tax expenditures Joint Committee of Taxation, Jan. 2012 $128 b $93 b $84 b $305 billion

47. The long-term problem is entitlements Concord Coalition. Data Source: CBO, Jan. 2012

48. 48 Social securitySocial security –Raise retirement age – just a little, perhaps exempting low-income workers.perhaps exempting low-income workers. –Index benefit growth to chain measure of inflation. –Further options: To please Democrats: Raise the cap on social security taxes.To please Democrats: Raise the cap on social security taxes. To please Republicans: encourage private accountsTo please Republicans: encourage private accounts –though they contribute nothing to closing the gap.

49. 49 Health careHealth care –Encourage hospitals to standardize around best-practice medicine. Pay health providers for “value,” not per medical procedure.Pay health providers for “value,” not per medical procedure. Standardize around best-practice treatment:Standardize around best-practice treatment: –evidence-based (to be facilitated by electronic health records). –E.g., pursue the checklist that minimizes patient infections, –and avoid unnecessary medical tests & procedures. –That is not “death panels.” Levers to get providers to follow best practices:Levers to get providers to follow best practices: –make Medicare payments conditional –or protection from malpractice litigation. –Curtail corporate tax-deductibility of health insurance, –especially gold-plated.

50. http://ksghome.harvard.edu/~jfrankel/http://ksghome.harvard.edu/~jfrankel/ Blog: http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/ Writings by J.Frankel on fiscal policy: On Graduation from Fiscal Procyclicality,” 2013, with C.Végh & G.Vuletin, J. Developmt. Econ. Summary: "Fiscal Policy in Developing Countries: Escape from Procyclicality," VoxEU, 2011. NBER WP 17619.Fiscal Policy in Developing Countries: Escape from Procyclicality17619 "Over-optimism in Forecasts by Official Budget Agencies and Its Implications," Oxford Review of Econ. Policy Vol.27, Issue 4, 2011, 536-62. NBER WP 17239; Summary in NBER Digest, Nov.2011. Oxford Review of Econ. PolicyVol.27, Issue 4, 17239SummaryNBER Digest “Snake-Oil Tax Cuts,” 2008, EPI, Briefing Paper 221. HKS RWP 08-056. EPIBriefing Paper 221HKS RWP 08-056 "Responding to Crises," Cato Journal vol.27, no. 2, Spring/Summer, 2007."Responding to Crises," “Republican and Democratic Presidents Have Switched Economic Policies,” Milken Institute Review 5, no. 1, 2003 QI.“Republican and Democratic Presidents Have Switched Economic Policies,”Milken Institute Review Google “Jeffrey Frankel Harvard” for webpage or blog http://content.ksg.harvard.edu/blog/jeff_frankels_weblog/

51. Addenda on US fiscal troubles 1. Pro-cyclicality in US fiscal policy 2. The long-term debt path is unsustainable 3. Consequences of recent Congressional show-downs for uncertainty; cost to the economy. 4. Can we balance the budget by cutting non-defense discretionary spending?

52. 1. Some US politicians have pursued pro-cyclical (i.e., destabilizing) fiscal policy. 1 st cycle: 1980-81: Reagan’s speeches pledging action to reduce the national debt “beginning today” came during a period of severe recession. Boom: profligacy. 1988: As the economy neared the peak of the business cycle, candidate George H.W. Bush was unconcerned about budget deficits: “Read my lips, no new taxes.” Recession: austerity.

53. Some US politicians have sought pro-cyclical fiscal policy, continued 2nd cycle 1990: The first President Bush summoned the political will to raise taxes & rein in spending (PAYGO) at precisely the wrong moment -- just as the US entered another recession. Boom: profligacy. 1993-2000: Despite the most robust recovery in US history, –1993: all Republican congressmen voted against Clinton’s legislation to continue PAYGO etc. –2000: Even after 7 years of strong growth, with unemployment < 4%, G. W. Bush campaigned on tax cuts. 2003: After his fiscal expansion had turned the inherited surpluses into deficits, GWB went for a 2 nd round of tax cuts & continued a spending growth rate > Clinton’s. – VP Cheney: “Reagan proved that deficits don’t matter.” Recession: austerity.

54. Some US politicians have sought pro-cyclical fiscal policy, continued 3rd cycle 2007-09: Predictably, when the new recession hit (worst since the 1930s ), Republican congressmen suddenly re-discovered the evil of deficits, deciding that retrenchment was urgent. –They opposed Obama’s initial fiscal stimulus in February 2009. 2011: Subsequently, with a majority in the House, they blocked further efforts by Obama when the stimulus ran out, – despite still-high unemployment; – and, instead cut spending. Recession: austerity.

55. Thus, through 3 cycles, the efforts at austerity came during recessions, followed by fiscal expansion when the economy was already expanding.

56. The US has its own version of biased forecasts Official US forecasts in the 2000s White House forecasts were over-optimistic. –OMB in Jan. 2001 forecast rapid rise in tax revenue, in effect assuming there would never be a recession. –Four tricks to justify tax cuts, dating from the 1980s: The Magic Asterisk Rosy Scenario Laffer Hypothesis Starve the Beast Hypothesis

57. The US version of biased forecasts, continued Official US forecasts in the 2000s Congressional Budget Office forecasts are honest. –But the Bush Administration adopted new tricks, –so that “current-law budget” would show future surpluses: continuation of Iraq & Afghan wars treated as a surprise each year; phony sun-setting of tax cuts…

58. National debt/GDP is the highest since WWII spike. Source: CBO, March 2012 2. The long-term US debt problem..

59. Long-term debt problem, continued Federal Not sustainable

60. 3. How far can we get by cutting spending? (2012 numbers) Start by eliminating PBS funding =1/10,000 of spending Then all foreign aid. = 1 ½ % of total outlays, not 25% as Americans think. Next, veterans’ benefits. The same. We are now up to a total of 3 % of outlays. Next imagine zeroing out all federal spending on agriculture, science & environment, education & transportation. That is a total of $364 b = 1/3 of the 2012 deficit. Conclusion: Domestic discretionary spending is not where the big bucks are. To eliminate the deficit we also need to eliminate either defense, –or medicare payments –or social security payments –while still collecting the social security taxes that are supposed to pay for it!

61. Eliminating all non-defense discretionary spending (including also parks, weather service, food safety, SEC, FBI, border patrol, politicians’ salaries… everything !) would not eliminate the budget deficit Concord Coalition. Data Source: CBO, Jan.2012 $6 b $30 b $17 b $56 b $35 b $61 b $59 b $86 b $92 b Total ≈ ½ 2011 deficit

62. Breakdown of federal spending Concord Coalition. Data Source: CBO, Jan. 2012 Tax revenue $2.5 tr. Deficit $1.1 tr. Budget deficit was $1.1 trillion in FY 2012 Even if one could somehow eliminate all domestic spending, it would not eliminate the deficit Outlays: $3.5 trillion Updated: http://cbo.gov/sites/default/files/cbofiles/attachments/2012_09_MBR.pdf

63. Uncertainty Reflected More in Headlines than in Markets Alec Phillips, Goldman Sachs Global Economics, Commodities and Strategy Research, Oct. 8, 2013 4.Economic uncertainty rises in response to fiscal showdowns but not as much in 2013 as it did at the time of the 2011 debt limit and, especially, the subsequent credit downgrade from AAA.

64. “New Study Measures the High Cost of Crisis-Driven Government” Macroeconomic Advisers, commissioned by Peterson Foundation, Oct.14 http://pgpf.org/press/2013/10/New-Study-Measures-the-High-Cost-of-Crisis-Driven-Government#sthash.88f38q7Q.dpuf Fiscal Policy Uncertainty : Since late 2009, fiscal policy uncertainty has raised the Baa corporate bond spread by 38 basis pts., lowered GDP growth by 0.3% points per year, & raised the unemployment rate in 2013 by 0.6% points, equivalent to 900,000 lost jobs. Discretionary Spending: Reductions in discretionary spending have reduced annual GDP growth by 0.7 % points since 2010 and raised the unemployment rate 0.8 % points, representing a cost of 1.2 million jobs. Government Shutdown : 2-week partial government shutdown alone directly trims 0.3% points from 4th-quarter growth. The Debt Ceiling: The paper considers two scenarios. The 1 st assumes a brief, technical default that is quickly resolved; the 2 nd assumes an extended, two-month stalemate. 1. In scenario one, risk aversion rises, financing costs rise, prices of risk assets fall, and the economy enters a recession. Growth only begins to rebound at end of 2014 and unemployment rate rises to a peak of 8.5% before starting to decline. At its peak, 2.5 million jobs would be lost. 2. Scenario two implies a longer and deeper recession than in the first scenario, but one characterized by extreme volatility. Annualized GDP growth fluctuates rapidly between plus and minus 8% until the oscillations diminish in 2015. Unemployment rises to a peak of 8.9% — equivalent to 3.1 million lost jobs.