More and more I have been asked why we should allow immigration when there is
so much domestic unemployment. It's a hard question to answer, more so when you
are talking to someone who is looking for a job and having a hard time finding
one. Similarly, people ask why we should allow imports on the belief that
restricting them would help with the domestic employment situation.
But one problem with protectionist measures is that they are like standing up to see better at a basketball game.
If everyone is sitting down and you stand up, you will, of course, see better.
You will be better off, so there will be a tendency to want to stand up,
particularly during crucial parts of the game. But if everyone else stands up
too, the result is different. Nobody can see any better than they could sitting
down (on average), and they are less comfortable standing than they were
sitting. All that happens as each person tries to stand up and improve their
situation is that everyone is made, collectively, worse off. (I realize some
people do prefer to stand - especially during the exciting periods of the game -
but for the purposes of the example I'm assuming the the highest utility outcome
is where everyone is sitting. If you don't like this example, think of a crowded freeway and someone leaving for work early to beat the traffic. If that person is the only one to leave early, or one of the few, it works, but if everyone tries to leave early, you get the same old freeway problems but everyone had to get up earlier - so they are worse off.). Same with protectionism. If one country imposes protectionist measures by itself, the measures can be helpful and hence there is a tendency to do this, but when all countries follow suit and retaliate with their own set of trade restrictions, it makes everyone worse off.
Will governments repeat the "Smoot-Hawley-like backlash against trade" that
occurred during the Great Depression? Barry Eichengreen says that could happen,
but fortunately we've learned a thing or two since then. e.g. the value of
fiscal policy, and hopefully that will keep the crowd under control:
Some of these fears relate to the protectionist rhetoric of Barack Obama... Then there are the bailouts for General Motors and
Chrysler. A subsidy for domestic auto producers is functionally equivalent to a
tax on the US sales of foreign producers. Finally there is the fear that the US
fiscal stimulus package ... will be rendered less effective if the increased
demand is allowed to leak out in the form of increased imports. US politicians
will be quick to react with protectionist measures if they see that today's
spending programmes, which create a debt burden for future generations, fail to
stimulate the American economy and only benefit other countries.
Fortunately there are reasons for thinking that this danger is overstated.
First, the growth of multinational production and global supply chains has
altered the political economy. Protecting US auto producers no longer
automatically benefits US parts suppliers when the Big Three source many of
their parts from Canada. Foreign companies with an interest in the maintenance
of free and open trade are better represented in the political process than they
were in the 1930s. ...
Second, in 1930 Congress resorted to Smoot-Hawley out of desperation over its
lack of alternatives. It was not that the Congress ... resorted to a tariff
to maximise the employment-creating impact from expansionary fiscal policies.
Rather the tariff was imposed instead of expansionary fiscal policies, there as
yet being no understanding of the case for fiscal stimulus. The danger of a
tariff as a convoluted employment-creating policy is now less, precisely because
we understand that there are direct ways for the government to stimulate demand,
namely by cutting taxes and raising public spending.
Finally, if fiscal stimulus and the Fed's zero interest rate policy mainly
suck in imports, then the dollar will decline in response to the widening
current account deficit. This will shift demand back toward domestic goods,
venting the pressure for a protectionist response. This is no mere hypothetical:
we have already seen the dollar falling in anticipation of just these
developments. This is fundamentally different from 1930, when the US and other
countries were on the gold standard and there was no scope for the exchange rate
to adjust. ...
Today, in contrast to the 1930s, our politicians have no shortage of policy
levers. They just need to pull the right ones.
The Big Bailout Lessons, by Harold Meyerson, Commentary, Washington Post:
Two things we learned about our ... economy in 2008: Lesson One: If
it's big and you don't regulate it, you end up nationalizing it. ...[U]nregulated
and underregulated capitalism ends up confronting democratic governments with a
subprime choice: Either let a major institution go down and watch as chaos
follows (the Lehman option) or funnel gobs of the public's money into such
institutions to avoid such Lehman-like chaos. ...
When the American financial industry came tumbling down this year, the
laissez-faire ideologues of this most ideological administration indulged their
ideology just once, allowing Lehman to go under. Thereafter, as one giant
institution after another tottered under the weight of dubious deals, the
administration tossed ideology out the window and funneled money to the banks.
Laissez faire be damned, the ideologues concluded: When handed a Lehman, make
The lesson for 2009 couldn't be clearer: To avoid nationalization, you need
regulation. Or, the lesson's ideological corollary: To avoid socialism (to
whatever extent throwing public money at banks is socialism), you need ... the
willingness to restrain capitalism from its periodic self-destruction...
Lesson Two: In matters economic, the Civil War isn't really over. ...Abraham
Lincoln ... might detect in the congressional war over the automaker bailouts a
strong echo of the war that defined his presidency. Now as then, the conflict
centered on the rival labor systems of North and South. Now as then, the
Southerners championed a low-wage, low-benefits system while the North favored a
more generous one. And now as then, what sparked the conflict was the North's
fear of the Southern system becoming the national norm. ...
Over the past century, of course, the conflict between North and South has
been between union and non-union labor. The states of the industrial Midwest and
the South ... developed two distinct economies. Residents of the unionized north
enjoyed higher ... paychecks and ... higher public
outlays on health and education, than did their counterparts in the
But, just as Lincoln predicted, the United States was bound to have one labor
system prevail, and the debate over the General Motors and Chrysler bailout was
really a debate over which system -- the United Auto Workers' or the foreign
transplant factories' -- that would be. ...
Roger Farmer says the Fed needs to target an asset price index "to prevent bubbles and
How to prevent the Great Depression of 2009, by Roger E.A Farmer, Financial
Times: ...Since world war two, economic policy in most western democracies
has been based on Keynesian economics. But although policy makers still rely on
Keynes' ideas, academics gave up on his theories 40 years ago and went back to
classical economics... The result has been 40 years of disconnect in which
policy makers are tinkering with the engine without a manual. ...
We have seen economies stagnate for a decade or more in the past - the UK in
the 1920s, the US in the 1930s and Japan in the 1990s - and it would be
presumptuous to think that this cannot happen again when the existing dominant
paradigm says that it could not happen in the first place.
Classical economists argue that falling wages will restore equilibrium; but
this is based on the belief that the labour market works like an auction in
which employment is determined by demand and supply.
It ignores the very real frictions involved in searching for a job by both
households and firms that can lead to many possible equilibrium employment
levels just as Keynes argued in the General Theory. ...
So where do we go from here? The only actor large enough to restore
confidence in the US market is the US government. The current policy of
quantitative easing by the Fed is a move in the right direction but it does not,
as yet, go nearly far enough.
It is time for a greatly increased role for monetary policy through direct
intervention of central banks in world stock markets to prevent bubbles and
crashes. Central banks control interest rates by buying and selling securities
on the open market.
A logical extension of this idea is to pick an indexed basket of securities:
one candidate in the US might be the S&P 500, and to control its price by buying
and selling blocks of shares on the open market.
Even the credible announcement that a policy of this kind was being
considered should be enough to boost the markets and restore consumer and
investor confidence in the real economy.
Critics will argue that this policy is dangerous socialist meddling. But I am
not arguing that the government should pick winners and losers: only that it
should stabilise a broad basket of stocks.
This policy would still allow poorly run firms to fail but it would not allow
all firms to fail at the same time. Although the free market is very good at
deciding how many left and right shoes to produce, it cannot prevent systemic
risk that arises from the psychology of herd behaviour. This is a job for Uncle
As I've noted many times, most recently
here, I am also warming up to the idea of having the Fed target an asset
price index in addition to inflation and unemployment. But there are lots of
questions to be answered first. What growth rate in the stock price index should we target? Should it
be 8%? Lower? Higher? What is the correct time frame? Day to day fluctuations are quite
volatile, we wouldn't want to react to every movement in the index, so how do we
come up with a core measure that gives us an indication of the long-run trend in
stock prices? Does value weighting, as in the S&P 500, give the optimal index, or
would some other weighting scheme do better? Do we only include financial
assets, or should other asset prices such an housing price index also be targeted? If so,
how would we do that? When targets are in conflict, how much weight should
deviations of the asset price index from its target value be given relative to
deviations of inflation and output from their target values? Will it still be true that it is optimal for the Fed to
react by raising the federal funds rate more than one to one in response to
changes in inflation? How will adding another source of variation to the federal
funds rate affect its smoothness? We don't fully understand why interest rate
smoothing is an important component of the Taylor rule, but it does seem to be an important, so how will this change will affect smoothness (it
depends upon how the coefficients in the Taylor rule are adjusted after the new
piece is added)?
And that's just a few of the questions, I'm sure I've overlooked many more (and please feel free to fill in the missing pieces in comments). Thus, while I certainly think this is a fruitful area to investigate, particularly in light of recent experience with the housing and stock price bubbles, we have more
thinking to do and more regressions to run before we are ready to implement this
kind of policy.
Finally, even with theoretical and empirical support, I'd be wary that asset
price targeting alone will be enough to prevent problems in asset markets from
developing in the future. Asset price targeting is a complement to other
measures such as regulatory and enforcement changes, not a substitute, and I
think it would be a mistake to believe simply twiddling with the policy rule
will be enough to avoid another financial market meltdown that threatens the
Update: Barkley Rosser, in comments, with an opposing view:
I spoke on the matter of "battling bubbles" at the Galbraith conference in New York. In November. I specifically suggested not doing something like this, or more generally not trying to use broad interest rate policy to influence speculative markets. However, I did support more targeted interventions in specific markets where there was good evidence of a serious speculative bubbles. I argued for using more specific regulatory tools along the lines suggested by Robert Feinman, such as changing margin requirements, or for housing tightening rules on mortgages, or for commodities, using buffer stocks (Strategic Petroleum Reserve, etc.) for interventions.
The real downside of using broad monetary policy to tamp down general stock market bubbles has been seen. It was called the Great Depression.
Also, keep in mind that we have not had a stock market bubble in recent years. We have had bubbles in housing and in oil and in some other commodities, but the P/E ratios have been pretty reasonable. The recent plunges of the stock market are not crashes of bubbles (the 2000 decline was, especially for dotcom stocks). Rather these are fundamental declines based on rationally expected declines in future profits and dividends.
Oh, and I do not see setting any sort of rule for this sort of thing as making any sense. It will have to be discretionary and case by case, keeping in mind that any such interventions will always be strongly opposed by those who are in the middle of making money from the bubble.
Update: Given the
recent discussion about whether the current recession is due to a reduced
willingness to work, I debated leaving this line about "contagious laziness" in, but didn't. Angus at Kids Prefer Cheese fills the void:
"In classical economics, the prices of stocks are determined by fundamentals
and the fundamentals of the economy are sound. The US had the same stock of
factories and machines in August that it had in July and the US workforce has
not been afflicted by a sudden attack of contagious laziness."
Franco Modigliani writing in the AER, March 1977:
"Sargent (1976) has attempted to remedy this fatal flaw by hypothesizing that
the persistent and large fluctuations in unemployment reflect merely
corresponding swings in the natural rate itself. In other words, what happened
to the United States in the 1930's was a severe attack of contagious laziness!"
Ouch! Can't one of the all-time greats of Macro get any love in this day and
The title of the article -- "Defense Spending Would Be A Great Stimulus" --
says it all. It's Feldstein's contention that additional military spending
should be part of whatever economic stimulus package Congress and the Obama
administration adopt in a few weeks.
Here are my objections almost paragraph by paragraph.
Philosopher of social science Daniel Little on "realists" versus "instrumentalists":
Correspondence, abstraction, and realism: Science is generally concerned
with two central semantic features of theories: truth of theoretical hypotheses
and reliability of observational predictions. ... Truth involves a
correspondence between hypothesis and the world; while predictions involve
statements about the observable future behavior of a real system. Science is
also concerned with epistemic values: warrant and justification. The warrant of
a hypothesis is a measure of the degree to which available evidence permits us
to conclude that the hypothesis is approximately true. A hypothesis may be true
but unwarranted (that is, we may not have adequate evidence available to permit
confidence in the truth of the hypothesis). Likewise, however, a hypothesis may
be false but warranted (that is, available evidence may make the hypothesis
highly credible, while it is in fact false). And every science possesses a set
of standards of hypothesis evaluation on the basis of which practitioners assess
the credibility of their theories--for example, testability, success in
prediction, inter-theoretical support, simplicity, and the like. ...
Whatever position we arrive at concerning the possible truth or falsity of a
given economic hypothesis, it is plain that this cannot be understood as literal
descriptive truth. Economic hypotheses are not offered as full and detailed
representations of the underlying economic reality. For a hypothesis unavoidably
involves abstraction, in at least two ways.
David Beckworth responds to the claim that this recession is due to "a
reduced willingness to work," and that "Labor demand shifts explain no more than
10 percent of what has happened in this recession":
[T]he decreased employment is explained more by reductions in the supply of
labor (the willingness of people to work) and less by the demand for labor (the
number of workers that employers need to hire).
If true, this claim means most of the 1,911,000 jobs lost since December 2007
are the result of voluntary choices made by employees. This interpretation
probably strikes most observers as ridiculous, but before we dismiss it out of
hand let's take a look at the employment data. The place for data on this
question is the BLS's Job Opportunity and Labor Turnover Survey (JOLTS). This survey provides data on job
openings, hires, and separations, and goes back to December 2000.
Because of the crisis, state and local governments are facing falling tax revenues, increased demand for social services, and high credit costs. These factors, along with balanced budget rules, are forcing cutbacks at the state and local level at a time when just the opposite is needed:
Fifty Herbert Hoovers, by Paul Krugman, Commentary, NY Times: ...[A]s
Washington tries to rescue the economy, the nation will be reeling from the
actions of 50 Herbert Hoovers — state governors who are slashing spending in a
time of recession, often at the expense both of their most vulnerable
constituents and of the nation’s economic future. ...
Now, state governors aren’t stupid (not all of them, anyway). They’re cutting
back because they have to... But ... contemplate just how crazy it is ... to be
cutting public services and public investment right now.
Think about it: is America — not state governments, but the nation as a whole
— less able to afford help to troubled teens, medical care for families, or
repairs to decaying roads and bridges than it was one or two years ago? Of
course not. Our capacity hasn’t been diminished; our workers haven’t lost their
skills; our technological know-how is intact. Why can’t we keep doing good
It’s true that the economy is currently shrinking. But that’s the result of a
slump in private spending. It makes no sense to add to the problem by cutting
public spending, too.
In fact, the true cost of government programs, especially public investment,
is much lower now than in more prosperous times. When the economy is booming,
public investment competes with the private sector for scarce resources — for
skilled construction workers, for capital. But right now many of the workers
employed on infrastructure projects would otherwise be unemployed, and the money
borrowed to pay for these projects would otherwise sit idle.
And shredding the social safety net at a moment when many more Americans need
help isn’t just cruel. It adds to the sense of insecurity that is one important
factor driving the economy down.
So why are we doing this to ourselves?
The answer, of course, is that state and local government revenues are
plunging along with the economy — and ... lower-level governments can’t borrow
their way through the crisis. Partly that’s because these governments ... are
subject to balanced-budget rules. But even if they weren’t, running temporary
deficits would be difficult. Investors, driven by fear, are refusing to buy
anything except federal debt...
Are governors responsible for their own predicament? To some extent. Arnold
Schwarzenegger, in particular, deserves some jeers. ... But even the best-run
states are in deep trouble. Anyway, we shouldn’t punish our fellow citizens and
our economy to spite a few local politicians.
What can be done? Ted Strickland, the governor of Ohio, is pushing for
federal aid ... on three fronts: help for the neediest, in the form of funding
for food stamps and Medicaid; federal funding of state- and local-level
infrastructure projects; and federal aid to education. That sounds right...
And once the crisis is behind us, we should rethink the way we pay for key
As a nation, we don’t believe that our fellow citizens should go without
essential health care. Why, then, does a large share of funding for Medicaid
come from state governments, which are forced to cut the program precisely when
it’s needed most?
An educated population is a national resource. Why, then, is basic education
mainly paid for by local governments, which are forced to neglect the next
generation every time the economy hits a rough patch?
And why should investments in infrastructure, which will serve the nation for
decades, be at the mercy of short-run fluctuations in local budgets?
That’s for later. The priority right now is to fight off the attack of the 50
Herbert Hoovers, and make sure that the fiscal problems of the states don’t make
the economic crisis even worse.
We know that excessive risk taking was a factor in the financial crisis, but
why people were willing to take on excessive risk?
There are several explanations for this. In one class of models, misperception of risk
generates excessive demand for risky assets, housing and financial assets in particular. There
are a variety of stories about why risk is misperceived, ratings agencies failed
to do their jobs, risk assessment models turned out to be wrong, people believed
that housing prices would continue to go up, and so on. The key is that in this class of
models the misperception of risk gives people a false sense of security, and induces them to take on
more risk than they can handle.
In another class of models, risk is misrepresented. Here, there is out and
out fraud or other practices where, essentially, people know that the house is
made of cards, but advertise it as being made of bricks anyway, and assure people that
it is perfectly safe. Fraud could cause the victim to misperceive risk, so this
is related to the first class of models, but I am trying to separate excessive risk taking brought about by intentional
misrepresentation from excessive risk taking brought about by errors in judgment (or, perhaps more accurately in some
cases, from negligence).
In a third class of models risk is misallocated, and there are two strands
of risk misallocation models. In one, the mechanism that causes people to take
excessive risk is knowledge that the government will step in and cover any
potential catastrophic losses (risk is reallocated from the private to the public sector). This is the moral hazard problem, and the claim
that government intervention led to excessive risk taking has been leveled pretty
much wherever government has played a role in housing and financial markets, even when the role
has not been very large.
In the second strand of risk
misallocation models, the cause of excessive risk taking is market failure due to principal agent problems (e.g. when mortgage brokers are paid according to the number of loans that pass through their hands rather than according
to the quality of the loans, and hence have no incentive to monitor risk). Market failures of
this type can cause excessive risk taking because the person taking the risks
does not face the full consequences of their decisions when the risky decisions turn out to be
wrong. Why not take a big risk if you win on the upside, but you don't have to pay the full cost (or any of the costs) on the downside? However, unlike the first strand of risk misallocation models where there is too much government intervention, here the problem can arise when government fails to regulate markets properly, so the problem is often the result of too little government intervention rather than too much.
In a final class of models government is also blamed, but this time government is a bully that forces banks - through regulation or moral suasion -
to make loans that are overly risky. The very thoroughly discredited models
blaming the Community Reinvestment Act for the financial crisis fit into this class, and the models blaming the CRA are the
most prominent member of this category. For that reason, I'll call these models
"misguided" and set them aside.
So which was it, misperception, misrepresentation, or misallocation? In the
following, Tyler Cowen focuses on the misallocation of risk due to government
induced moral hazard. My own view is that misallocation of risk did play a role,
but I think risk misallocation due to market failures, i.e. the failure of regulation, was more important in generating the crisis than moral hazard brought about by implicit or explicit government guarantees. I also think the misperception
of risk was important, perhaps even more important than the misallocation of risk (though these are sometimes hard to separate):
At the time, it may have seemed that regulators did the right thing. The
bailout did not require upfront money from the government, and the world avoided
an even bigger financial crisis. Today, however, that ad hoc intervention by the
government no longer looks so wise. With the Long-Term Capital bailout as a
precedent, creditors came to believe that their loans to unsound financial
institutions would be made good by the Fed — as long as the collapse of those
institutions would threaten the global credit system. Bolstered by this sense of
security, bad loans mushroomed. ...
The Long-Term Capital episode ... was important precisely because the fund
was not a major firm. At the time of its near demise, it was not even a major
money center bank, but a hedge fund with about 200 employees. Such funds hadn’t
previously been brought under regulatory protection this way. After the episode,
financial markets knew that even relatively obscure institutions — through
government intervention — might be able to pay back bad loans.
The major creditors of the fund included Bear Stearns, Merrill Lynch and
Lehman Brothers, all of which went on to lend and invest recklessly and, to one
degree or another, pay the consequences. But 1998 should have been the time to
send a credible warning that bad loans to overleveraged institutions would mean
losses, and that neither the Fed nor the Treasury would make these losses good.
What would have happened without a Fed-organized bailout of Long-Term
Capital? ... Fed inaction might have had grave ... economic consequences,... and
the economy would have probably plunged into recession. That sounds bad, but it
might have been better to have experienced a milder version of a downturn in
1998 than the more severe version of 10 years later.
In 1998, there was no collapsed housing bubble, the government’s budget was
in surplus rather than deficit, bank leverage was much lower, and derivatives
markets were smaller and less far-reaching. A financial crisis related to
Long-Term Capital, however painful, probably would have been easier to handle
than the perfect storm of recent months.
The ad hoc aspect of the bailout created a precedent for what has come to be
called “regulation by deal” — now the government’s modus operandi. Rather than
publicizing definite standards and expectations for bailouts in advance, the Fed
and the Treasury confront each particular crisis anew. ... So far, every deal —
or lack thereof, in the case of Lehman Brothers — has been different.
While there are some advantages to leaving discretion in regulators’ hands,
this hasn’t worked out very well. It has become increasingly apparent that the
market doesn’t know what to expect and that many financial institutions are
sitting on the sidelines, waiting to see what regulators will do next.
Regulatory uncertainty is stifling the ability of financial markets to engineer
at least a partial recovery. ...
I should add that I agree with Tyler that government action, or in some cases inaction, and in still other cases poorly though out action, particularly by the Treasury, has left far too much uncertainty in markets.
I am going to go out on a limb and assume this is the result of unintended inventory
accumulation rather than, say, firms building up inventories in anticipation of
an economic boom that is just around the corner. If so, then this is not a good omen for labor demand.
Why is the word demand highlighted? The graph is mostly an excuse to note this from Brad Delong:
Casey Mulligan says--wait for it--that the reason that unemployment
is the 7% it is right now rather than the 4.4% it was two years ago
because workers today face "financial incentives that encourage them
not to work":
Are Employers Unwilling to Hire, or Are Some Workers Unwilling to Work?:
Employment has been falling over the past year... if total hours worked
had continued the upward trend they had been on in the years before the
recession, they would be 4.7 percent higher than they are now....
[Today s]ome employees face financial incentives that encourage them
not to work.... [T]he decreased employment is explained more by
reductions in the supply of labor (the willingness of people to work)
and less by the demand for labor (the number of workers that employers
need to hire)...
Believe it or not
this explanation made it in print:
Because productivity has been rising ... the decreased employment is
explained more by reductions in the supply of labor (the willingness of people
to work) and less by the demand for labor (the number of workers that employers
need to hire).
As pgl notes, Casey Mulligan doesn't tell us why labor supply suddenly shifted inward, he promises that will be divulged later, but he does have a solution to the unemployment problem. He calls for--wait for it--tax cuts:
Why would some people have fewer incentives to take a job in 2008
than they did in 2006 and 2007 (and employers fewer incentives to create jobs)?
I will tackle that question in my next post, but even without a specific answer
we learn a lot about today’s recession from the conclusion that labor supply –
not labor demand – should be blamed. First of all, it suggests that a
fundamental solution to the recession would encourage labor supply (perhaps
cutting personal income tax rates, so people can keep more of their wages),
rather than tinker with demand.
Tax cuts could also work by increasing the demand for goods and services and hence the demand for labor, but this is a supply-side explanation where workers refuse to work at the wages being offered to them and decide to stay home instead, so that is not the mechanism he has in mind.
Dean Baker isn't buying the labor supply explanation. As he notes, a key component of this explanation is the claim by Mulligan that, "Unlike in the severe recessions of the 1930s and early 1980s, productivity has been rising." But why has productivity been rising relative to previous recessions? Dean Baker explains:
The one piece of data that drives this story is the apparent strength of
productivity growth in this downturn relative to prior ones. But, there is a
real simple story that can explain this pattern.
If we assume that in prior downturns firms were reluctant to lay off workers,
both because of union contracts and also because they recognized the cost of
turnover and hiring new workers, then we would expect sharp downturns in
productivity growth as soon as there is a downturn in demand.
Now, imagine that firms are not constrained by union contracts and don't
worry about long-term costs, so that they quickly layoff workers when there is a
falloff in demand. Voila! productivity does not fall off in the same way in this
That would be my story. We can try to do some more careful examination of
declines in productivity sector by sector, but I suspect that this is what
explains the difference in productivity patterns across downturns.
Whatever the explanation - and productivity is not easy to measure so the relationships in the data can be questioned - I find it highly implausible that worker's unwillingness to accept the jobs being offered to them is the source of the current employment problem.
As difficult as these conditions are, however, the Obama administration also
inherits an economy with great potential for the medium and long terms.
Investments in an array of areas -- including energy, education, infrastructure
and health care -- offer the potential of extraordinarily high social returns...
In this crisis, doing too little poses a greater threat than doing too much.
Any sound economic strategy in the current context must be directed at both
creating the jobs ... and doing the work that our economy requires. ... Our
president-elect ... is crafting a broad proposal, the American Recovery and
Reinvestment Plan, to support the jobs and incomes essential for recovery while
also making a down payment on our nation's long-term financial health.
A key pillar of the Obama plan is job creation. In the face of deteriorating
economic forecasts, Obama has revised his goal upward, to 3 million. .... The
Obama plan represents not new public works but, rather, investments that will
work for the American public. Investments to build the classrooms, laboratories
and libraries our children need to meet 21st-century educational challenges.
Investments to help reduce U.S. dependence on foreign oil by spurring renewable
energy initiatives... Investments to put millions of Americans back to work
rebuilding our roads, bridges and public transit systems. Investments to
modernize our health-care system, which is ... key to driving down costs across
the board. ...
We must focus not on ideology but on drawing the best ideas from all
quarters. That is why, for example, in key sectors such as energy, Obama is
pushing for both public investments and the removal of barriers to private
investment. It is also why his plan relies on both government spending and tax
cuts to raise incomes and promote recovery. ...
There will be no earmarks. Investments will be chosen ... based on what
yields the highest rate of return for the economy and monitored closely not just
by officials but also by the public as government becomes more transparent. We
expect to evaluate and to be evaluated rigorously to ensure that Washington is
held accountable for how tax dollars are spent.
Some argue that instead of attempting to both create jobs and invest in our
long-run growth, we should focus exclusively on short-term policies that
generate consumer spending. But that approach led to some of the challenges we
face today -- and it is that approach that we must reject if we are going to
strengthen our middle class and our economy over the long run. ...
How can the incoming administration manage to navigate the "treacherous political
waters safely" as it attempts to rescue the economy?:
Barack Be Good, by Paul Krugman, Commentary, NY Times: Times have changed.
In 1996, President Bill Clinton, under siege from the right, declared that “the
era of big government is over.” But President-elect Barack Obama, riding a wave
of revulsion over what conservatism has wrought, has said that he wants to “make
government cool again.”
Before Mr. Obama can make government cool, however, he has to make it good.
Indeed, he has to be a goo-goo.
Goo-goo, in case you’re wondering, is a century-old term for “good
government” types, reformers opposed to corruption and patronage. Franklin
Roosevelt was a goo-goo extraordinaire. He simultaneously made government much
bigger and much cleaner. Mr. Obama needs to do the same thing. ...
Like the New Deal, the incoming administration must greatly expand the role
of government to rescue an ailing economy. But also like the New Deal, the Obama
team faces political opponents who will seize on any signs of corruption or
abuse — or invent them, if necessary — in an attempt to discredit the
F.D.R. managed to navigate these treacherous political waters safely, greatly
improving government’s reputation even as he vastly expanded it. ... How did
F.D.R. manage to make big government so clean?
A large part of the answer is ...oversight... The Works Progress
Administration, in particular, had a powerful, independent “division of progress
investigation” devoted to investigating complaints of fraud. This division was
so diligent that ... a Congressional subcommittee ... couldn’t find a single
serious irregularity that the division had missed.
F.D.R. also made sure that Congress didn’t stuff stimulus legislation with
pork: there were no earmarks in the legislation ... for the W.P.A. and other
Last but not least, F.D.R. built an emotional bond with working Americans,
which helped carry his administration through the inevitable setbacks ... that
beset its attempts to fix the economy.
So what are the lessons for the Obama team?
First, the administration of the economic recovery plan has to be squeaky
clean. Purely economic considerations might suggest cutting a few corners in the
interest of getting stimulus moving quickly, but the politics of the situation
dictates great care in how money is spent. And enforcement is crucial:
inspectors general have to be strong and independent, and whistle-blowers have
to be rewarded, not punished as they were in the Bush years.
Second, the plan has to be really, truly pork-free. Vice President-elect
Joseph Biden recently promised that the plan “will not become a Christmas tree”;
the new administration needs to deliver on that promise.
Finally, the Obama administration and Democrats in general need to do
everything they can to build an F.D.R.-like bond with the public. Never mind Mr.
Obama’s current high standing in the polls based on public hopes that he’ll
succeed. He needs a solid base of support that will remain even when things
aren’t going well. ...
Democrats are off to a bad start on that front. The attempted coronation of
Caroline Kennedy as senator plays right into 40 years of conservative propaganda
denouncing “liberal elites.” And surely I wasn’t the only person who winced at
reports about the luxurious beach house the Obamas have rented, not because
there’s anything wrong with the first family-elect having a nice vacation, but
because symbolism matters, and these weren’t the images we should be seeing when
millions of Americans are terrified about their finances.
O.K., these are early days. But that’s precisely the point. Fixing the
economy is going to take time, and the Obama team needs to be thinking now, when
hopes are high, about how to accumulate and preserve enough political capital to
see the job through.
What can the incoming administration learn about infrastructure spending from Eisenhower's experience in creating the interstate highway system?:
Eisenhower's roads to prosperity, by Tom Lewis, Commentary, LA Times:
...President-elect Barack Obama vowed to "create millions of jobs by making the
single largest new investment in our national infrastructure since the creation
of the federal highway system..." The story of President Eisenhower's decision
in 1956 to create the interstate highway system ... holds lessons that the new
president and the country would do well to heed.
Eisenhower was the first Republican to occupy the White House after Herbert
Hoover, who in the 1950s still wore a mantle of shame for his role in the market
crash of 1929 and its aftermath. Eisenhower had an almost pathological, but
healthy, fear that he might be blamed for allowing the nation to fall into
another depression. When a mild recession ... pushed the unemployment rate above
5%, Eisenhower ... asked for solutions.
The highwaymen at the Bureau of Public Roads ... heeded the call. They
reported that each federal dollar invested in construction generated close to
one half-hour of employment. ... Workers across America, not just those who
built the roadways, would benefit -- in cement and steel plants (50 tons of
concrete and 20 tons of reinforcing steel go into each mile), in paint and sign
manufacturers and in heavy equipment factories and oil refineries. ...
Eisenhower realized that he could not fail with highways. Americans wanted
more roads for their postwar cars. Construction would prime the economic pump
... and help secure the nation's future. He signed ... the $25-billion
Federal-Aid Highway Act to build a 42,000-mile interstate highway system by
1972. Ultimately the cost would escalate to more than $130 billion, and workers
would not finish the roads until 1993...
Eisenhower wasn't afraid to create a huge public works program, and unlike
today's presidents, he wasn't afraid of taxes. ... The 1956 highway bill levied
a tax of 3 cents on each gallon of fuel -- equal to 24 cents today. The revenue
went into a dedicated highway trust fund. ...
Eisenhower's interstates are an essential part of our culture. ... In 1956,
Eisenhower likely didn't fully realize that he was creating not just a public
works program but an economic and social blueprint for the next 50 years. Now,
along with every other aspect of our infrastructure, the interstates are
crumbling. Irresponsible legislators rail against the current federal highway
tax of 18.4 cents a gallon -- far less in today's prices than Eisenhower's 3
cents. Seduced by easy money, governors consider leasing parts of the highway
system to foreign companies.
So the lessons for Obama are clear: Don't be afraid to propose bold -- and
often expensive -- programs that improve the nation's infrastructure and
peoples' lives, and don't be afraid to pay for them with taxes.
It is said the 44th president is taking office at a Lincoln moment and a
Roosevelt moment. True enough, but it can be an Eisenhower moment as well.
Keeping the budget in balance while the economy is struggling is not good
policy. If the goal is to stimulate the economy and to create new jobs, then the
"clear" lesson - the advice to pay for the spending on infrastructure by raising
taxes - is wrong. The new infrastructure does need to be paid for, but the time
to do that is when the economy is healthy, not when it is under performing.
[E]ven if Obama and other world leaders do everything right, the US and the
global economy are in for a difficult period. The question is not only how long
the recession will last, but what the economy will look like when it emerges.
Will it return to robust growth, or will we have an anemic recovery, à la
Japan in the 1990’s? Right now, I cast my vote for the latter, especially since
the huge debt legacy is likely to dampen enthusiasm for the big stimulus that is
required. Without a sufficiently large stimulus (in excess of 2 percent of GDP),
we will have a vicious negative spiral: a weak economy will mean more
bankruptcies, which will push stock prices down and interest rates up, undermine
consumer confidence, and weaken banks. Consumption and investment will be cut
Many Wall Street financiers, having received their gobs of cash, are
returning to their fiscal religion of low deficits. It is remarkable how, having
proven their incompetence, they are still revered in some quarters. What matters
more than deficits is what we do with money; borrowing to finance
high-productivity investments in education, technology, or infrastructure
strengthens a nation’s balance sheet.
The financiers, however, will argue for caution: let’s see how the economy
does, and if it needs more money, we can give it. But a firm that is forced into
bankruptcy is not un-bankrupted when a course is reversed. The damage is
If Obama follows his instinct, pays attention to Main Street rather than Wall
Street, and acts boldly, then there is a prospect that the economy will start to
emerge from the downturn by late 2009. If not, the short-term prospects for
America, and the world, are bleak.
Ban Ki-moon, Secretary General of the United Nations, says "We stand on the
threshold of a new multilateralism":
Taking the Long View, by Ban Ki-moon,
Project Syndicate: The coming year will be a narrative of tension - a series
of difficult choices between the imperatives of the present and those of
tomorrow. How we resolve this tension will be the measure of our vision and our
As a community of nations, we face three immediate tests in the coming year.
Neuroscientists Daniel Kahneman and Amos Tversky received a 2002 Nobel Prize
for their 1979 research that argued humans rarely make rational decisions. Since
then, this has become conventional wisdom among cognition researchers
Contrary to Kahnneman and Tversky's research, Alex Pouget ... has
shown that people do indeed make optimal decisions—but only when their
unconscious brain makes the choice.
"A lot of the early work in this field was on conscious decision making, but
most of the decisions you make aren't based on conscious reasoning," says Pouget.
"You don't consciously decide to stop at a red light or steer around an obstacle
in the road. Once we started looking at the decisions our brains make without
our knowledge, we found that they almost always reach the right decision, given
the information they had to work with."
The ... most important lesson is that one should not treat the economy as a
morality tale. In the 1930s, two opposing ideological visions were on offer: the
Austrian; and the socialist. The Austrians ... argued that a purging of the
excesses of the 1920s was required. Socialists argued that socialism needed to
replace failed capitalism, outright. These views were grounded in alternative
secular religions: the former in the view that individual self-seeking behaviour
guaranteed a stable economic order; the latter in the idea that the identical
motivation could lead only to exploitation, instability and crisis.
Keynes’s genius – a very English one – was to insist we should approach an
economic system not as a morality play but as a technical challenge. He wished
to preserve as much liberty as possible, while recognising that the minimum
state was unacceptable to a democratic society with an urbanised economy. He
wished to preserve a market economy, without believing that laisser faire makes
everything for the best in the best of all possible worlds.
This same moralistic debate is with us, once again. Contemporary
“liquidationists” insist that a collapse would lead to rebirth of a purified
economy. Their leftwing opponents argue that the era of markets is over. And
even I wish to see the punishment of financial alchemists who claimed that ever
more debt turns economic lead into gold.
Yet Keynes would have insisted that such approaches are foolish.
Economics learns a thing or two from
Economics is supposed to be a solid
discipline, founded on complex mathematical models (and we all know math is
really, really difficult). They even give Nobel prizes to economists, for crying
out loud! And yet, economics has always had to fight off the same reputation of
being a “soft” science that has plagued sociology, psychology, and to some
extent even some of the biological sciences, like ecology and evolutionary
biology. Indeed, like practitioners in those other fields of inquiry, some
economists admit of being guilty of “physics envy,” that is, of using the
physical sciences as the model for what their field ought to be like. Turns out
even the assumption that a good science should be modeled on physics is
“flawed,” to use Greenspan’s apt phrase.
A recent article by Chelsea Wald in Science
(12 December 2008) puts things in perspective by asking how it is possible that
so many smart people in the financial sector made irrational decisions over a
period of years, despite clear data showing there was a problem, and eventually
leading to a worldwide economic crisis that is at the least poking at, if not
shaking, the foundations of capitalism itself.
Part of the answer is to be found in the
persistent idea in economics that “markets” work because people are rational
agents who act in their own self-interest and have perfect, instantaneous access
to relevant information about the businesses they are considering investing in.
Economists are not stupid, and they know very well that perfect rationality,
complete information and instant access are all light years away from the
reality of how markets operate. And in fact recent models have relaxed these
assumptions to some extent. But it is so much more tractable to model things
that way! After all, physicists do it too: remember those problems in Physics
101 that started “consider a spherical cow…”?
That logic is exactly backwards. As President-elect Barack Obama and his
economic advisers recognize, countering a deep economic recession requires an
increase in government spending to offset the sharp decline in consumer outlays
and business investment... Although tax cuts for individuals and businesses can
help, government spending will have to do the heavy lifting. ...
A temporary rise in DOD spending ... should be a significant part of that
increase in overall government outlays. ... The increase in government spending
needs to be a short-term surge ... but then tail ... off sharply in 2011 when
the economy should be almost back to its prerecession level of activity. Buying
military supplies and equipment, including a variety of off-the-shelf dual use
items, can easily fit this surge pattern. ...
An important challenge for those who are designing the overall stimulus
package is to avoid wasteful spending. One way to achieve that is to do things
during the period of the spending surge that must eventually be done anyway. It
is better to do them now when there is excess capacity...
Replacing the supplies that have been depleted by the military activity in
Iraq and Afghanistan is a good example of something that might be postponed but
that should instead be done quickly. ...
Industry experts and DOD officials confirm that military suppliers have
substantial unused capacity... With industrial production in the economy as a
whole down sharply, there is no shortage of potential employees who can produce
supplies and equipment. ...
Now is also a good time for the military to increase recruiting and training.
... As a minimum this would provide education in a variety of technical skills
-- electronics, equipment maintenance, computer programming, nuclear facility
operations, etc. -- that would lead to better civilian careers for this group.
It would also provide a larger reserve force...
The current two-year stimulus period provides an opportunity for additional
temporary spending increases with high payoffs. Investments in port security
would reduce a major homeland vulnerability. Expanding the government's language
training programs ... would provide more translators... Additional
infrastructure for the FBI would remove an important constraint on the number of
new FBI agents. ...
A substantial short-term rise in spending on defense and intelligence would
both stimulate our economy and strengthen our nation's security.
In fact, we have a magic bullet for short-term spending and long-term
saving--health care reform. During the campaign, skeptics complained that a
health care overhaul would involve a lot of upfront costs and that the saving
would only come later. But that's exactly what we need right now. Health care
involves major spending in the near future, but, more than other initiatives, it
will put a brake on federal outlays in the far future.
All this argues for temporarily throwing fiscal caution to the wind when it
comes to health care reform. The idea of spiking the deficit now may seem
frightening, but it's a lot better than the alternative--and it could actually
make it easier to bring universal health care to America. ...
The typical items on the stimulus menu--infrastructure spending, general aid
to the states, benefits for the jobless, investments in new forms of
energy--have a lot going for them. But they shouldn't blind us to the fact that
government health spending is also an extraordinarily effective way to boost the
[F]ixing health care isn't just a recipe for better access to medical care.
It's an immediate economic lifeline for working families, giving them back part
of their income to use on other things. It's also a rescue package for state and
local governments burdened by Medicaid and S-CHIP, for doctors and hospitals who
treat the uninsured and inadequately insured, for community institutions that
help people in distress--in short, for all the rapidly fraying threads of our
health care safety net. Put simply, most of the money we spend upgrading
coverage and spreading it to the uninsured is going to go directly into the
pockets of people who need help now. ...
The beauty of all this spending is that it will mean higher wages and
employment, a more flexible labor market in which people feel free to change
jobs or strike out on their own without risking their health and finances, and,
yes, less pressure on public and private budgets down the road. We'll be running
up hefty federal bills for a while. But we'll be doing so confident we're going
to improve the economic standing of millions of Americans and our long-term
budget situation in the bargain.
Cochrane had been teaching at the bastion of free-market economics for 14
years and this struck at everything that he -- and the school -- stood for.
“We all wandered the hallway thinking, How could this possibly make sense?”
says Cochrane, 51, recalling his incredulity at Paulson’s attempt to prop up the
mortgage industry and the banks that had precipitated the housing market’s boom
During a lunch..., Cochrane, son-in-law of Chicago efficient-market theorist
Eugene Fama, and some colleagues made their stand. They wrote a petition
attacking Paulson’s proposal, sent it to economists nationwide and collected 230
signatures. Republican Senator Richard Shelby of Alabama waved the document as
he scorned the rescue. ... “We should have a recession,” Cochrane said...
[M]uch of the academic world is reassessing Chicago School hallmarks. ... Off
campus, the global meltdown is stirring anti-Chicago economists, who were voices
in the wilderness during decades of lax government oversight of markets.
Joseph Stiglitz ... says the approach of Friedman and his followers helped
cause today’s turmoil. “The Chicago School bears the blame for providing a
seeming intellectual foundation for the idea that markets are self- adjusting
and the best role for government is to do nothing,” says Stiglitz...
Robert Lucas says monetary policy can still effectively stimulate new
spending even though the target interest rate is already at or near zero, and
that monetary policy is preferable to fiscal policy:
the Best Stimulus, by Robert E. Lucas Jr., Commentary, WSJ: The Federal
Reserve's lowering of interest rates last Tuesday was ... received with
skepticism. Once the federal-funds rate is reduced to zero, or near zero,
doesn't this mean that monetary policy has gone as far as it can go? This widely
held view was appealed to in the 1930s to rationalize the Fed's passive role as
the U.S. economy slid into deep depression.
It was used again by the Bank of Japan to rationalize its unwillingness to
counteract the deflation and recession of the 1990s. In both cases, constructive
monetary policies were in fact available but remained unused. Fed Chairman Ben
Bernanke's statement last Tuesday made it clear that he does not share this view
and intends to continue to take actions to stimulate spending.
There should be no mystery about what he has in mind. Over the past four
months the Fed has put more than $600 billion of new reserves into the private
sector... This action has been the boldest exercise of the Fed's
lender-of-last-resort function in the history of the Federal Reserve System. Mr.
Bernanke said that he is prepared to continue ... this discounting activity as
long as the situation dictates.
Why do I describe this as an action to stimulate spending? Financial markets
are in the grip of a "flight to quality" that is very much analogous to the
"flight to currency" that crippled the economy in the 1930s. Everyone wants to
get into government-issued and government-insured assets, for reasons of both
liquidity and safety. Individuals have tried to do this by selling other
securities, but without an increase in the supply of "quality" securities these
attempts do nothing but drive down the prices of other assets. The only other
action people can take as individuals is to build up their stock of cash and
government-issued claims to cash by reducing spending. This reduction is a main
factor in inducing or worsening the recession. Adding directly to reserves --
the ultimate liquid, safe asset -- adds to supply of "quality" and relieves the
perceived need to reduce spending. ...
Could the $600 billion in new reserves be called a bailout? In a sense, yes:
The Fed is lending on terms that private banks are not willing to offer. They
are not searching for underpriced "bargains" on behalf of the public, nor is it
their mission to do so. Their mission is to provide liquidity to the system by
acting as lender-of-last-resort. We don't care about the quality of the assets
the Fed acquires in doing this. We care about the quantity of its liabilities.
There are many ways to stimulate spending, and many of these methods are now
under serious consideration. ... But monetary policy ... has been the most
helpful counter-recession action taken to date, in my opinion, and it will
continue to have many advantages in future months. It is fast and flexible.
There is no other way that so much cash could have been put into the system as
fast as this $600 billion was, and if necessary it can be taken out just as
quickly. The cash comes in the form of loans. It entails no new government
enterprises, no government equity positions in private enterprises, no price
fixing or other controls on the operation of individual businesses, and no
government role in the allocation of capital across different activities. These
seem to me important virtues.
There's a reason they used to be called "monetarists". If we wait to see if
monetary policy does, in fact, work as advertised and we find out that it
doesn't, it will be too late to implement effective fiscal policy. So yes, by
all means use monetary policy to the best of our ability, but let's not forget
about fiscal policy. If monetary policy is as fast and flexible as claimed, then
it can always be reversed in the event that fiscal policy kicks in with more
force than expected.
As to the argument that fiscal policy distorts the allocation of capital, that
doesn't necessarily happen. As I've
argued in the past:
One reason I am not as concerned with the efficiency aspect as others is that
I believe there are a lot of public goods - goods the private sector won't
invest in on its own due to market failures - that we need to repair or put into
place that are crucial to our long-run growth potential. Cutting taxes won't
bring these goods about... For this reason, I don't think government spending
[necessarily] loses to tax cuts on ... the efficiency ... margin...
And as Paul Krugman argued yesterday:
Bad anti-stimulus arguments: A number of conservative economists have been
arguing against a stimulus plan centered on government spending. Fair enough.
But one argument I keep reading bugs me: it’s the claim that spending-based
stimulus is bad because economic theory tells us that a marginal dollar of
private spending is better than a marginal dollar of government spending.
That’s just wrong... Yes, the standard theory of consumer choice says that a
consumer gains more utility if he or she gets to freely allocate a dollar of
spending than if someone else makes the choices: I’d rather buy myself a $10
meal than have you feed me $10 worth of food that you select.
But that’s not what we’re talking about when we talk about stimulus spending:
we’re not talking about the government buying consumption goods for the public
at large. Instead, we’re talking about spending more on public goods: goods that
the private market won’t supply, or at any rate won’t supply in sufficient
quantities. things like roads, communication networks, sewage systems, and so
on. And every Econ 101 textbook explains that the provision of public goods is a
necessary function of government.
When we’re asking whether it’s better to have the government stimulate the
economy or to try to stimulate private spending, we’re asking among other things
whether a marginal dollar spent on public goods is worth more or less than a
marginal dollar spent on private consumption. And there’s nothing, even in Econ
101, that clearly favors private spending on private goods over public spending
on public goods. ...
The misallocation point is not central to Lucas' argument about why fiscal
policy is inferior to monetary policy, but it is part of it. Among
conservatives who do believe fiscal policy is needed, however, the misallocation argument
is a central part of their insistence that tax cuts dominate government spending
as a fiscal stimulus measure. But, again, this ignores the public goods aspect
of the spending.
A proposal to rebalance consumption and investment in China:
The China Growth Fantasy, by Yasheng Huang, Commentary, WSJ: Remember the
hype about "decoupling"? Not so long ago, Western analysts -- in particular
investment-bank economists -- were peddling the idea that China had become ...
able not only to drive its own growth independent of the United States but also
to power the global economy forward.
To the extent that these Wall Street economists are still employed, few would
make that argument now. The economic numbers emerging out of China are sobering.
... Clearly China is not bucking global trends.
So how did all the decoupling theorists get it so wrong? ...
The Value of Reliable Information, by Mark Thoma, Greenspan Roundtable, The
Economist: Analysts writing about the credit crisis often have more certainty about the
source of the problems in financial markets than I think is warranted. Thus,
rather than advocating robust solutions, these analysts tend to come up with
narrow answers to the problems they have identified. Yet evidence from previous
crises suggests that America needs to take a broad approach to the current
Janet Yellen, the president of the Federal Reserve Bank of San Francisco,
recently returned from her annual fact-finding trip to Japan. While there, the
country's policymakers and economic officials reflected on their experience with
Japan's "lost decade" (during the 1990s) and suggested several approaches for
resolving the crisis in America. Summarising the recommended approaches, Ms
One is to provide a safety net for the financial system during a crisis by
extending deposit insurance and to enhance interbank liquidity by guaranteeing
debt. Another emphasizes the importance of the government's role in
recapitalizing the banks, provided that there are conditions about reducing
risky lending and that the government stands to gain from future bank profits.
Finally, analysts universally concluded that the government needs to help
banks get toxic assets off their balance sheets. Otherwise, banks will remain
focused on the potential for further deterioration of these loans at the expense
of looking forward and making new loans. Thus, new capital will be hoarded to
protect against potential new losses. Equally important is price discovery. In
Japan, the government took severe haircuts in purchasing assets from banks (in
2000). This policy reduced uncertainty by establishing a floor price for future
asset sales. Everyone we met with urged the U.S. to move forward with an asset
disposition program, as originally envisioned for the Troubled Asset Relief
Thus, the recapitalisation that
Alan Greenspan advocates (public or private) is part of the process needed
to help repair financial markets, but if Japan's experience tells us
anything—and it's one of the few examples we have to look at—it is by no means
the only step that should be taken. There may be a single key to unlocking the
whole mess, but if there is we aren't sure what it is, and that also points to a
multi-pronged approach. Capital injections are one part of that approach, but
capital injections do not, by themselves, adequately address problems such as
the risk and information issues that Brad DeLong
outlines. A successful solution must address all of the elements of the
So where do the solutions that have been suggested come up short? If you read
across the spectrum of serious proposals, and look at what has actually been
implemented, most of the underlying problems have at least been recognised. But
one area that has not received nearly enough attention is the information
problem. Previous financial crises did not cause us to seriously question our
informational architecture like this one has. This crisis has wiped out or
discredited major sources of financial-market information that are crucial for
credit markets to function. The ratings agencies are an obvious example. They
are supposed to solve an asymmetric information problem between borrowers and
lenders by giving those doing the lending a reliable assessment of the riskiness
of financial investments. They failed in that mission.
Likewise, the balance sheets of financial institutions are no longer
trusted—assessing a firm's solvency is largely a guess at this point. People are
not going to part with their money until they are confident that the information
about potential investments, and about the firms managing those investments, is
reliable. That is true for both depositors and potential equity holders who
could help with recapitalisation. We can take toxic assets off the books, but
how will investors know for sure that new financial assets are safe, or that the
firms doing the investing won't repeat the mistakes of the past and take huge
losses yet again? How will investors know that the mathematical models used to
assess these assets in terms of risk and return are reliable?
I don't think anything trustworthy can replace the ratings agencies in the
short-run—nobody has much faith in the risk-assessment models being used in the
industry—and that will be a problem as firms begin to issue new securities, a
step that is needed to get credit flowing. There might be more we can do with
respect to balance-sheet information, but this problem also seems to stem from
the difficulty investors have in valuing financial assets.
The solution to this problem, then, is to provide insurance against the risks
caused by the lack of information during the time period when the information
flows are being restored. Private-sector agents may not want to risk putting
their money into the banking system right now as equity holders if they believe
they might lose everything. But if the downside risk is limited through some
insurance provision—something that puts a limit on losses—they might not be so
reluctant (and government may be the only one capable of such guarantees).
Similarly, private-sector agents may be unwilling to invest in financial assets,
or to trust money managers if they believe their money can suddenly disappear.
Again, though, if the downside losses are limited, they might not be so
reluctant. There are many, many forms this type of insurance can take, and the
solutions can be based in both the public and private sectors. The important
thing is to get the insurance into place.
So my recommendation would be to continue to pursue a broad-based strategy
that addresses the many problems that have been suggested as potential causes of
the crisis, and to bolster the initiatives that help to overcome the information
and credibility issues that have arisen as big barriers to the flow of new
credit. On the information and credibility issue, it's important to recognise
that even if we recapitalise every bank that is in trouble, remove every
existing toxic asset on every bank balance sheet, and refinance every mortgage
so that it is not in danger of default, we still will not have fully repaired
financial markets. We will still be left with a lack of trust—for good reason—in
the informational architecture people use to make financial decisions. Until
that is repaired—which will require a new regulatory structure, among other
things—these markets will not perform to their full potential without some sort
of insurance against the lack of credible information.
It may take a lot longer than many people think for the economy to be ready
to stand on its own:
Life Without Bubbles, by Paul Krugman, Commentary, NY Times: Whatever the
new administration does, we’re in for months, perhaps even a year, of economic
hell. After that, things should get better, as President Obama’s ...
economic recovery plan ... begins to gain traction. Late next year the economy
should begin to stabilize, and I’m fairly optimistic about 2010.
But what comes after that? ... Too much of the economic commentary I’ve been
reading seems to assume ... that ... once a burst of deficit spending turns the
economy around we can quickly go back to business as usual.
In fact, however, things can’t just go back to the way they were... I hope
the Obama people understand that.
The prosperity of a few years ago, such as it was — profits were terrific,
wages not so much — depended on a huge bubble in housing, which replaced an
earlier huge bubble in stocks. And since the housing bubble isn’t coming back,
the spending that sustained the economy in the pre-crisis years isn’t coming
back either. ... Consumers will eventually regain some of their confidence, but
they won’t spend the way they did...
So what will support the economy if cautious consumers and humbled
homebuilders aren’t up to the job? ... Something new could come along...,
perhaps ... a boom in business investment.
But this boom would have to be enormous, raising business investment to a
historically unprecedented percentage of G.D.P., to fill the hole left by the
consumer and housing pullback. While that could happen, it doesn’t seem like
something to count on.
A more plausible route to sustained recovery would be a drastic reduction in
the U.S. trade deficit, which soared at the same time the housing bubble was
But it will probably be a long time before the trade deficit comes down
enough to make up for the bursting of the housing bubble. For one thing, export
growth ... has stalled, partly because nervous international investors, rushing
into assets they still consider safe, have driven the dollar up against other
Furthermore, even if the dollar falls again, where will the capacity for a
surge in exports and import-competing production come from? ...U.S.
manufacturing ... has a lot of catching up to do.
Anyway, the rest of the world may not be ready to handle a drastically
smaller U.S. trade deficit. ...China’s economy in particular is built around
exporting to America, and will have a hard time switching...
In short, getting to the point where our economy can thrive without fiscal
support may be a difficult, drawn-out process. And as I said, I hope the Obama
team understands that.
Right now, with the economy in free fall and everyone terrified of Great
Depression 2.0, opponents of a strong federal response are having a hard time
finding support. John Boehner, the House Republican leader, has been reduced to
using his Web site to seek “credentialed American economists” willing to add
their names to a list of “stimulus spending skeptics.”
But once the economy has perked up a bit, there will be a lot of pressure on
the new administration to pull back, to throw away the economy’s crutches. And
if the administration gives in to that pressure too soon, the result could be a
repeat of the mistake F.D.R. made in 1937 — the year he slashed spending, raised
taxes and helped plunge the United States into a serious recession.
The point is that it may take a lot longer than many people think before the
U.S. economy is ready to live without bubbles. And until then, the economy is
going to need a lot of government help.
George Soros says we need to revise regulation to keep bubbles "within
tolerable bounds," but we also need to be careful of going too far:
Revise regulation, the theory of market equilibrium is wrong, by George Soros,
Commentary, Project Syndicate: We are in the midst of the worst financial
crisis since the 1930s. The salient feature of the crisis is that it was not
caused by some external shock like OPEC raising the price of oil. It was
generated by the financial system itself. This fact - a defect inherent in the
system - contradicts the generally accepted theory that financial markets tend
toward equilibrium and deviations from the equilibrium occur either in a random
manner or are caused by some sudden external event to which markets have
difficulty in adjusting. The current approach to market regulation has been
based on this theory, but the severity and amplitude of the crisis proves
convincingly that there is something fundamentally wrong with it.
I have developed an alternative theory which holds that financial markets do
not reflect the underlying conditions accurately. They provide a picture that is
always biased or distorted in some way or another. More importantly, the
distorted views held by market participants and expressed in market prices can,
under certain circumstances, affect the so-called fundamentals that market
prices are supposed to reflect. ...[...continue
James Kwak says it's likely that the new administration will get behind the
Hubbard and Mayer plan to have Fannie and Freddie buy mortgages and refinance
them at 4.5%:
We Have a Winner?, by James Kwak: After seeing dozens of
mortgage proposals emerge over the past several months, there are news stories
that Larry Summers and the Obama economic team are converging on an unlikely
candidate: the proposal by Glenn Hubbard and Christopher Mayer... Hubbard and
Mayer published a
summary of the
plan in the WSJ last week; a
longer version of the op-ed is available from their web
site; and you can also download the
full paper, with all the models.
I say “unlikely” not only because Hubbard was the chairman of President
Bush’s Council of Economic Advisors, but because it doesn’t look like a
Democratic plan; then again, it doesn’t look much like a Republican plan,
either. ... Before getting to the policy specifics, though, I want to outline
two of the premises...
For A Sunday Morning, by Tim Duy: An unusually quiet Sunday morning –
the kids are with their grandparents, leaving me with a chance to think of
something beyond the immediate economic data. This morning that meant a stream
of thoughts triggered by Paul Krugman’s most
recent op-ed, particularly this:
Most of all, the vast riches being earned — or maybe that should be “earned”
— in our bloated financial industry undermined our sense of reality and degraded
Think of the way almost everyone important missed the warning signs of an
impending crisis. How was that possible? How, for example, could Alan Greenspan
have declared, just a few years ago, that “the financial system as a whole has
become more resilient” — thanks to derivatives, no less? The answer, I believe,
is that there’s an innate tendency on the part of even the elite to idolize men
who are making a lot of money, and assume that they know what they’re doing.
In this paragraph, Krugman sounds less like an economist and more like a
philosopher. But I am not complaining in the least; economists lost a sense of
the essential humanity of their topic when they gravitated down a path of
sanitized mathematical and statistical methodology. Indeed, I often think that
economists share no small blame for our current economic challenges, as the
profession provided the intellectual basis for free markets but often failed to
place that ideology in a larger social perspective. It is as if the profession
followed the path of The Wealth of Nations but forgot The Theory of
Moral Sentiments. The latter is Adam Smith’s philosophical tome, and if you
can only read one of these two, it is my recommendation. I suspect that Krugman
had TMS in mind when he wrote the above paragraphs. An excerpt from Smith:
Second, and unfortunately, the financial crisis has moved to emerging
countries. In crossing borders, the sharp portfolio reallocations and the rush
to safer assets are creating not only financial but also exchange-rate crises.
Add to this the drop in output in advanced countries, and you can see how
emerging countries now suffer from both higher credit costs and decreased export
Third, in the advanced economies, the hit to wealth, and even more so the
specter of another Great Depression, has led people and firms to curtail
spending sharply... The result has been a sharp drop in output and employment,
reinforcing fears about the future, and further decreasing spending.
Let me now turn to policy. If my characterization of events is correct, then
the right set of policies is straightforward:
Alan Blinder isn't happy with Treasury Secretary Paulson's use of TARP money:
Missing the Target With $700 Billion, by Alan S. Blinder, Economic View, NY
Times: ...It pains me to say this, because I was among the first to call
upon Congress to create two institutions to deal with the financial crisis: one
to buy and refinance home mortgages, the other to buy what came to be called
“troubled assets.” The legislation signed in October empowered the TARP to do
both. Sadly and amazingly, it has done neither. ... Instead, taxpayer money has
been used [by Treasury Secretary Henry M. Paulson Jr.] mainly to recapitalize
ailing banks. ...
Because about half of the $700 billion remains uncommitted, let’s review the
arguments supporting the three main uses of the TARP:
Mortgages: The financial crisis began with falling home prices and
fears of rampant mortgage defaults — fears that are now coming true. Those fears
depressed the values of securities based on mortgages, making them “troubled.”
... It is hard to see a way out of this mess without seriously reducing
foreclosures. Understanding that, Congress directed the Treasury secretary to
use the TARP to get mortgages refinanced. But he has not.
Mortgage-Related Securities: There were several rationales for buying
troubled mortgage-backed securities. First, panic had virtually shut down the
markets for these securities... Second, one source of that panic was that nobody
knew what the securities were worth. A functioning market would establish
objective valuations. Third, many mortgages are buried in complex securities.
Buying the securities would let government refinance the underlying mortgages.
Mr. Paulson says he changed his mind about buying troubled assets because the
facts changed. I’m sure that many facts changed. But what new facts invalidate
the rationales above? ...
Recapitalizing Banks: Granting the secretary catch-all authority to
buy “any other financial instrument” was a sensible addendum to the law. It
offered much-needed flexibility to respond to unforeseen circumstances — an auto
bailout, for example. But whoever imagined that the addendum would consume
nearly all the TARP money, leaving nothing for its two stated purposes?
But suppose you believe (though I don’t) that recapitalizing banks was the
best use of all the money. Even then, the secretary’s execution leaves much to
be desired. Never mind the lack of transparency and the management issues
recently cited by the Government Accountability Office. Think about this:
Treasury has bought preferred stock with no control rights. The 5 percent
dividend rate that taxpayers will generally receive is half what Warren Buffett
got from Goldman Sachs. Banks receiving capital injections through the front
door are generally allowed to pay dividends out the back door. And there are no
public-purpose quid pro quos, such as a minimal lending requirement. So banks
can just sit on the capital... Clearly, Mr. Paulson bent over backward to make
the terms attractive to banks. ...
So here we are, looking at an all-too-familiar story. The administration that
brought you the Iraq war and the Katrina response is locking in another disaster
before it leaves town. What to do?
Fortunately, the TARP legislation ... Congress a mechanism for blocking
release of the second $350 billion. With the first tranche now committed, Mr.
Paulson said he would soon request release of the second. Based on his
performance to date, Congress should reject that request unless he agrees to
spend most of the next installment on TARP’s two stated purposes.
Failing that, we can wait a month for the new Treasury secretary, Timothy
“Eye for eye, tooth for tooth,” Mr. Blanders
explained. “It's really quite simple enough. Suppose you, in the Martian corpus,
break a leg on the last day of Occupancy. You suffer the pain, to be sure, but
not the subsequent inconvenience, which you avoid by returning to your own
undamaged body. But this is not equitable. Why should you escape the
consequences of your own accident? Why should someone else suffer those
consequences for you? So, in the interests of justice, interstellar law requires
that, upon reoccupying your own body, your own leg be broken in as scientific
and painless a manner as possible.”
“Even if the first broken leg was an
“Especially if it were an accident. We
have found that the Reciprocal Damage Clause has cut down the number of such
accidents quite considerably.” [Robert Sheckley, Mindswap (New York:
Dell, 1966), p. 17.]
Instead of borrowing somebody's body, Wall
Street borrows their money. But when they do the equivalent of breaking your leg
- when they damage the deposits they are holding - they don't always suffer any
consequences. In fact, many of them get to keep the large bonuses they earned
for managing the money so poorly, e.g. see Krugman's latest
column. A broken leg clause is a bit on the thuggish side, of course,
financial penalties are more acceptable, but this does make clear the need for
money managers to "feel your pain" in order to get the incentives correct.
To point out that experts are wrong, however, is to misunderstand the purpose of
them. Their function is not to provide knowledge, and still less clear thinking.
Instead, it is to provide certainty. People hate dissonance, doubt and
uncertainty. Experts help dispel these. So, Paul Britton’s function was to tell
the police that they had the right man, whilst economic forecasters’ job is to
provide an impression that the future is knowable; no-one wants to hear about
errors, parameter uncertainty or the
What’s so pernicious here, though, is that people have ways of achieving an
illusory certainty anyway. As Sir Harry Ognall - the judge who acquitted Stagg -
“The police closed their minds to any other possibility than that of his guilt.”
There are several ways they got these closed minds. All have analogues in
corporate planning and financial trading.
The Madoff Economy, by Paul Krugman, Commentary, NY Times: The revelation
that Bernard Madoff — brilliant investor (or so almost everyone thought),
philanthropist, pillar of the community — was a phony has shocked the world, and
understandably so. The scale of his alleged $50 billion Ponzi scheme is hard to
Yet surely I’m not the only person to ask the obvious question: How
different, really, is Mr. Madoff’s tale from the story of the investment
industry as a whole?
The financial services industry has claimed an ever-growing share of the
nation’s income over the past generation, making the people who run the industry
incredibly rich. Yet, at this point, it looks as if much of the industry has
been destroying value, not creating it. And it’s ... had a corrupting effect on
our society as a whole.
Let’s start with those paychecks. ... The incomes of the richest Americans
have exploded over the past generation, even as wages of ordinary workers have
stagnated; high pay on Wall Street was a major cause of that divergence.
But surely those financial superstars must have been earning their millions,
right? No, not necessarily. The pay system on Wall Street lavishly rewards the
appearance of profit, even if that appearance later turns out to have been an
Consider the hypothetical example of a money manager who leverages up his
clients’ money..., then invests the bulked-up total in high-yielding but risky
assets... For a while — say, as long as a housing bubble continues to inflate —
he (it’s almost always a he) will make big profits and receive big bonuses.
Then, when the bubble bursts and his investments turn into toxic waste, his
investors will lose big — but he’ll keep those bonuses.
O.K., maybe my example wasn’t hypothetical after all.
So, how different is what Wall Street in general did from the Madoff affair?
Well, Mr. Madoff allegedly skipped a few steps, simply stealing his clients’
money rather than collecting big fees while exposing investors to risks they
didn’t understand. ... Still, the end result was the same (except for the house
arrest): the money managers got rich; the investors saw their money disappear.
We’re talking about a lot of money here. In recent years the finance sector
accounted for 8 percent of America’s G.D.P., up from less than 5 percent a
generation earlier. If that extra 3 percent was money for nothing — and it
probably was — we’re talking about $400 billion a year in waste, fraud and
But the costs of America’s Ponzi era surely went beyond the direct waste of
dollars and cents.
At the crudest level, Wall Street’s ill-gotten gains corrupted and continue
to corrupt politics... Meanwhile, how much has our nation’s future been damaged
by the magnetic pull of quick personal wealth, which for years has drawn many of
our best and brightest young people into investment banking, at the expense of
science, public service and just about everything else?
Most of all, the vast riches ... undermined our sense of reality and degraded
our judgment. Think of the way almost everyone important missed the warning
signs of an impending crisis. How was that possible? ... The answer, I believe,
is that there’s an innate tendency on the part of even the elite to idolize men
who are making a lot of money, and assume that they know what they’re doing.
After all, that’s why so many people trusted Mr. Madoff.
Now, as we survey the wreckage and try to understand how things can have gone
so wrong, so fast, the answer is actually quite simple: What we’re looking at
now are the consequences of a world gone Madoff.
Can the Fed's current policy be described as quantitative easing?:
Zero, But Not Quite Quantitative Easing, by Tim Duy: On the surface,
the Fed’s recent statement should not have been much of a surprise. It was
remarkably consistent with Fed Chairman Ben Bernanke’s recent policy speech. And
it leaves little illusion that the US economy is mired in anything but the worst
recession since the Great Depression.
My takeaways from the statement were straightforward:
1.) Since the effective funds rate was trading well below the Fed’s target,
and it was economically unimportant in any event, just take the target to a
range near zero. I assume that given the instability of financial markets, they
thought it best not to prescribe a specific target, but a range instead.
2.) The Fed committed to low rates indefinitely, giving market participants
faith that they can extend Treasury purchases further out along the yield curve without
fear of a sharp policy reversion in the near future. (Does the Fed’s commitment
to low rates leave Treasuries as the last one way bet?)
3.) Not surprisingly, economic weakness, not inflation, is the primary
concern. There is no reason for near term optimism.
4.) Policy will focus on the tools that reveal themselves in the Fed’s
balance sheet. Those tools may be expanded to include outright purchases of
longer dated Treasuries.
The final point is worth considering further, especially since the Fed
brought forth a “senior Fed official” to elaborate on the statement. I don’t
quite understand the need for secrecy – why not have Bernanke himself just step
up to the plate? In any event, the secret official took pains to explain that
this policy did not constitute quantitative easing. First, the statement:
The focus of the Committee's policy going forward will be to support the
functioning of financial markets and stimulate the economy through open market
operations and other measures that sustain the size of the Federal Reserve's
balance sheet at a high level.
What struck me on the first read was the commitment to maintain the balance
sheet at a high “level.” I think the use of the word “level” was deliberate –
quantitative easing implies a commitment to a steady expansion, or rate of
change, in the balance sheet. The Fed is offering no such commitment at this
time. Is this the proper interpretation? From the senior official:
The Fed said in its statement today that it will be using its balance sheet
to support credit markets and the economy. Some analysts have called the
approach quantitative easing — effectively expanding the money supply once
interest rates cannot be eased further — as Japan did during its economic
But the senior Fed official said the central bank’s approach is distinct from
quantitative easing and different from what the Japanese did.
What, stop….the arrogance of Fed officials never ceases to amaze me! Note
that this official accuses “[S]ome analysts” as misinterpreting the Fed’s policy
stance. I have written on this
in the past:
…What we have now is an expansion of the balance sheet to accommodate
liquidity measures. This may pave the way to quantitative easing, but still
maintains the Fed Funds rate as the primary target.
But then why do they keep saying they have a policy of quantitative easing?
This first crossed my radar when reviewing a recent interview with Dallas
Federal Reserve President Richard Fisher. I discounted his reference to
quantitative easing as Fisher is something of a colorful character who often
talks before he thinks. But subsequent policymakers repeated the term. Earlier
this week New York Fed President Gary Stern was quoted by Stephen Beckner:
Asked whether the doubling in size of the balance sheet represents
"quantitative easing," Stern said "I don't think that's a bad statement. I think
the world is a little more complicated than that, but I don't think that's a bad
So, just to be clear, it is not just “some analysts” who are confused by the
Fed’s policy – the confusion spills over to Fed policymakers as well. Maybe
analysts would not be confused if Fed officials would simply stick to one set of
According to the official, we are not in the realm of quantitative easing.
What is the distinction?
The Fed’s balance sheet has two sides, the official explained: assets with
securities the Fed holds (including loans, credit facilities, mortgage-backed
securities) and liabilities (cash and bank reserves). Japan’s quantitative
easing program focused on the liability side, expanding cash in the system and
excess reserves by a large amount. The Fed’s focus, however, is on the asset
side through mortgage-backed securities, agency debt, the commercial paper
program, the loan auctions and swaps with foreign central banks. That’s designed
to improve credit-market functioning, the official said. By expanding the
balance sheet by making loans, the official explained, the focus is not on
excess reserves but on the asset side. That securities-lending approach directly
affects credit spreads, which is the problem today — unlike Japan earlier, where
the problem was the level of interest rates in general, the official said.
Fed policy has been directed at improving credit market functioning, thereby
acquiring assets, of which the expansion of liabilities is simply a side affect
of the policy, not the policy itself. The Fed apparently views deliberate
expansion of liabilities – a commitment of x% percent growth in some monetary
aggregate via Treasury purchases – as quantitative easing. A commitment to
increase the balance sheet at a steady pace (the first derivative) rather than
maintain a high level. We are not there yet.
Is this distinction important? Or just semantics? I believe it is important,
as the latter, a move to target the liabilities side of the balance sheet, would
imply that the Fed is deliberately trying to stoke an inflationary fire. This
may become the future policy, but for now the Fed is simply trying to keep the
financial system from collapsing. Inflation would be an accident, not a
deliberate policy effort, at least from the Fed’s point of view. For the moment,
the policy remains insufficient to ward off deflationary pressures long as the
rest of the world refuses to accept the burden of global adjustment.
The problem, in my mind, is that the rest of the world either refuses or is
simply incapable of shouldering some of the burden of global adjustment. This
inability to adjust appears to be the end result of almost thirty years of
global acceptance and US indifference to external imbalances. Global consumption
and production patterns,
spacially and intertemporally, are so misaligned that it looks like we are
all now in a race to the bottom together. An amazing global policy failure. So,
So when does Fed policy truly become inflationary? Currently, I am thinking
it becomes inflationary when policymakers become desperate enough to attempt to
use monetary policy to entirely offset the headwinds blowing against economic
activity. When they truly attempt to target asset prices to “fix” the housing
market. When they decide the easiest answer to the excessive build up of debt is
to inflate it away. At that point, policy will shift from the asset side of the
balance sheet to the liability side. That is when Treasury and the Fed will risk
a disorderly adjustment of the Dollar. Hopefully we will not get there. But I
suspect that is when the tide will turn for the Fed.
In a modern economy, the prospects of businesses are likely to be
interdependent, with each company’s success (and ability to repay) depending on
whether other companies obtain financing. Companies commonly use components and
services from other businesses and often sell their output to other companies or
Consider a bank choosing whether to lend to companies or park its capital in
treasuries. Suppose that lending to any given company will generate an expected
return of 10 per cent if other businesses obtain financing but an expected loss
of 5 per cent if they do not. In such circumstances, the economy may get stuck
in an inefficient credit freeze in which banks expect other banks to avoid
lending and, given these expectations, rationally choose to hoard their capital
to avoid the expected loss from lending when other banks do not.
Unfortunately, we cannot count on interest rate cuts and capital infusions
into banks to get the economy out of such a credit freeze..., avoiding the 5 per
cent expected loss will remain each bank’s rational choice as long as other
banks are not lending.
Is there anything more the government could do? Yes, it can ... take on ...
some of the credit risks involved in extending substantial new lending to
Suppose that the government wishes to get at least $200bn of additional
lending to companies. Under one possible mechanism, the government would
facilitate ... loans by agreeing to bear part of any losses ... in return for a
share of the upside. In the example considered above, to induce banks to put
together ... new loans it would be sufficient for the government to agree to
bear any losses ... up to 10 per cent of the value of the extended loans.
The share of the upside received by the government could be determined
through a competitive process. ... Under an alternative mechanism, the
government would place $200bn in a number of funds. Each would be run by a
private manager charged with putting together a portfolio of loans and
compensated with a share of the profits generated by the fund. ...
When capital infusions and interest rate cuts do not work, the mechanisms we
propose might provide effective tools for unfreezing credit markets.
The demand for loans is also a limiting factor, and I don't think making more loans available to businesses will be enough to jump-start the economy at this point. So more help for the economy than just making additional credit available will be required.
However, Ricardo Caballero says the problem isn't as hard to fix as most people believe:
Normality is just a few policy steps away: Economic agents of all sorts, from creditors to consumers, are frozen waiting
for some sense of normality to be restored amid the financial crisis. However,
normality is much closer —just a few bold policy steps away— than is the
conventional wisdom. ...
I do not mean to say that this recession is an imaginary one. On the
contrary, I believe it is a very serious recession. My point is simply that good
policy has an opportunity to bring the recession back to familiar turf by
defeating the extra gloom, and if this happens, the recession will become a
manageable one from which current asset prices, on average, will look like
once-in-a-lifetime deals. ...
Slow recoveries follow the typical credit crunch... But ... this ... is very
different in nature. It is a systemic run on all forms of explicit and implicit
insurance contracts, but with no shortage of resources on the side. If
confidence recovers, the resources to support the recovery are abundant and