This week, President Obama signed the Small Business Jobs Act, which aims to help get credit flowing back into small business investments and job creation. Along similar lines, Federal Reserve Chair Ben Bernanke proposed in late August that the Fed should start purchasing long-term government securities as a means of lowering long-term interest rates (though the Fed declined to act on Bernanke’s proposal at last Tuesday’s Open Market Committee meeting).

These measures are steps in the right direction. But with unemployment officially at 9.6 percent fifteen months after the recession officially ended—and a more accurate unemployment figure for today being close to 20 percent—these are small steps at a time when bold strides are required. And with federal deficit-financed stimulus programs for unemployment insurance, education, healthcare and public safety considered politically untouchable, what are other large-scale programs that could contribute to a strong recovery? In a paper for a recent New America Foundation Forum,"Plan B for Economic Recovery," University of Massachusetts–Amherst economics professor Robert Pollin offers a plan that deserves a wider audience.

Pollin argues that the single most important reason for the failure of the economic recovery to take hold thus far is that private credit markets are locked up, especially for small business. Private business borrowing and lending is at a standstill, while private banks are holding an unprecedented $1.1 trillion in cash reserves in their Federal Reserve accounts. In 2007, before the recession began, the banks held only $20 billion in reserves. The 2007 figure was itself dangerously low, but a nearly $1 trillion turnaround in bank reserve holdings is a new form of Wall Street excess.

Pollin proposes that the federal government create strong incentives on both the borrowing and lending sides of the market to push affordable credit back into the market—again, especially for small businesses—where these funds will start financing business investments and job creation. The federal government already has the power to accomplish this with minimal impact on the federal budget. (It would mean working with existing policy tools and agencies, in particular the loan guarantee program now operating at the Small Business Administration.)

This proposal could be a grand compromise between Obama and Wall Street. Consider that this policy includes just two main features, one carrot and one stick. The carrot is an expansion of existing federal loan guarantees by $300 billion, which would roughly double the amount total annual guarantees. Small businesses would be the primary recipients of the guarantees.

The stick is an initial 1-2 percent tax on the excess reserves held by banks. This will create a strong disincentive for banks to continue holding excess reserves. (Congress, operating in conjunction with the Fed, should adjust the rate as needed to ensure that excess bank reserves are getting channeled into job-generating investments.)

Pollin estimates that this program could generate about 3 million new jobs, if it succeeds in pumping about $300 billion into new productive investments. The job creation levels would be significantly higher if a large proportion of the new business spending were for "green" activities, where the levels of job creation per dollar of expenditure are about 50 percent greater than the economy-wide average. The impact of the program on the federal budget would be modest, most likely no more than additional 0.3–0.5 percent increase in federal spending to cover the guarantees on defaulted loans. Some of these costs could also be covered from the revenues generated by the reserve tax.

This should be a program that everyone can support. Who could be against measures that have the potential to generate millions of jobs, provide cheap credit for small businesses, dramatically lower the level of risk for banks to support small businesses and do all of this on the cheap? And for those deficit vigilantes, remember the only direct cost of this program would be covering the guarantees on defaults. Finally, all of this can be accomplished with relatively modest administrative costs for the federal government.

Read Robert Pollin’s February 2010 feature on the Obama administration’s job creation policies.