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Wednesday, January 07, 2009

"Has America Lost Its Mojo?"

Ken Rogoff says the pessimists are probably going too far when they say the economy is headed for "a second worldwide Great Depression":

Has America Lost Its Mojo?, by Kenneth Rogoff, Project Syndicate: You know that American self-confidence is shaken when even the President starts expressing fear that the financial crisis may turn out worse than the Great Depression...

Professional forecasters ... forecast ... U.S. growth in 2009 at around -1.5 percent... This would be a painful recession, but far short of the 10-15 percent output drop normally associated with a full-blown depression. Of course, economic forecasters have generally been far too optimistic ... of late, so the public is understandably leery of their prognostications.

Consensus forecasts do still seem optimistic. With its financial system on life support, housing prices continuing to plummet, and unemployment rising, the U.S. economy is looking ... vulnerable...

Still, it must be noted that negative output growth for more than two years is a relatively rare event, even in the aftermath of severe banking crises. Historical statistical relationships are perhaps cold comfort... But they should not be dismissed. ...

The basic elements of a recovery package include, first and foremost, a rational approach to rebooting the financial system. This means mark-to-market pricing of assets, restructuring and recapitalizing banks, and a new approach to regulation... Help for housing is required to prevent overshooting in home prices, as is massive macroeconomic stimulus, including a moderately inflationary monetary policy.

A number of leaders, most prominently German Chancellor Angela Merkel, are understandably worried about the longer-term consequences of aggressive macroeconomic stimulus. These concerns are valid, even more so given government's growing role in the economy. But, as in wartime, one hopes these effects are temporary. Besides, is inaction a real alternative?

Prior to the 1950s, output drops of 15-20 percent in a single year were routine (admittedly, national income accounting was more primitive.) A number of academic economists say we should simply tough it out as we did back then. Recessions have important cleansing effects, helping to facilitate painful restructuring.

But today's social, economic, and political systems ― at least in developed countries ― are unable to withstand a peacetime decline in output of 15-20 percent within a short period. Massive stimulus and intervention ... is unavoidable. One can only hope that the state can get out of the economy half as fast as it is getting in. Nevertheless, the distinct possibility that stimulus and restructuring may work is further cause to hope that the deepening recession will not morph into a full-blown depression. ...

[J]ust as optimists were too sanguine in the boom, ultra-pessimists probably go too far in forecasting a depression around the corner. 2009 will be a tough year. Yet, absent a large-scale conflagration, there is a fair chance that 2010 will see a restoration of weak growth in the U.S., Europe, and Japan, and probably robust growth in most emerging markets. The U.S. economy may have lost a fair chunk of its mojo, but it will require a lot more bad luck and policy blunders to get to .

    Posted by on Wednesday, January 7, 2009 at 02:07 PM in Economics, Financial System, Policy | Permalink  TrackBack (0)  Comments (82)


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