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Sunday, May 22, 2011

DeLong: The Economic Outlook as of May 2011

Brad DeLong is in Phoenix delivering bad news about the prospects for the economy (I cut quite a bit from the original, so you may want to read the full post):

The Economic Outlook as of May 2011: Yes, This Is Called the Dismal Science. Why Do You Ask?, by Brad Delong: ...This is a bad time to be an economist. ... Four years ago we economists were writing learned papers about the "Great Moderation": about how it looked as though the governing institutions of the world economy had finally learned how to control and moderate if not completely eliminate the business cycle...
We have been seeing these ... business cycles fairly regularly since at least 1825. And we have been claiming that we have it licked fairly regularly since 1825 as well. ... But did we learn? No. We did it again.
In the 2000s,... we were happy to take credit for superior macroeconomic management that had caused the "Great Moderation" and finally tamed the business cycle. ...
And now we are sitting here in the middle of the greatest macroeconomic catastrophe since the Great Depression itself, and we economists are all scratching our heads and saying: "what happened?" ...
We economists ... had worries about Wall Street. But our worries were not about systemic risk arising from subprime.
Some of our worries were about Glass-Steagall repeal. Others were about Fannie Mae. ... But... It simply was not the case in the 2000s that those post-Glass-Steagall investment banks with large commercial banking deposits were in any sense engaged in riskier behavior than those that had only hot money liabilities. ... And Fannie Mae was not the big problem. ...
As the foundations of this crisis were laid, there were always arguments against massive regulatory intervention to deal with it. Those arguments always sounded convincing. ... The first argument was: "well it is their money." Countrywide probably knows what it is doing. ...
Second, Alan Greenspan really is a Randite, really is a follower of Ayn Rand. He really does believe that it is a bad thing to infringe your freedom and protect you from yourself. He really is the kind of person who thinks that it is bad for you if the government keeps you from making stupid investments that cost you all your money. ...
The third argument was: "who is going to get hurt?" Investors in Countrywide, but they are rich and risk-loving and if they want to build the rest of us houses we should probably say "thank you." ... So why should the government step in and keep people from getting these deals if Countrywide wants to provide them?
Fourth, and most important, it is a big political loser for regulators to go before Congress. The Democratic members would whack them: why aren’t you letting my constituents buy the houses they want to buy? The Republican members would whack them: why aren’t you letting my contributors make the loans they want to make?" ...
Fifth, there was the fact that the old framework for lending locked lots of people out of the real estate asset class, and ... that we should be trying to broaden the access of the poorer half of Americans to high-return investment vehicles.
Most important, however, was the overall belief on the part of the regulators that they could handle it. Subprime was a small asset class in the global economy. The Federal Reserve was powerful. Whatever stupid things financial markets did, the Federal Reserve could clean up the mess afterwards...
Even in the spring of 2008, when I was a worrywort, the general line was that all the losses in subprime mortgages had a maximum value of $500 billion in a global economy with an $80 trillion asset base. A loss of $500 billion out of a total of $80 trillion is not, should not be the kind of thing that could set the whole financial system on fire. ...
So we had the crisis, and the collapse. We had the subprime losses. We had the general panic as everybody feared that the large highly-leveraged money-center banks' debt was no good because they held a lot of subprime and their subprime losses had eaten through their capital. And we had a bigger panic as people feared other things that might go wrong--the same financial establishment that had no clue what risks they were running in subprime probably had other points of vulnerability as well. All confidence that the highly-trained and highly-compensated risk management professionals on Wall Street knew what they were doing evaporated.
It was the standard story. It was the story that we have seen over and over again since 1825. ...
Now, this downturn is not nearly as bad as it could have been. Kevin O'Rourke and Barry Eichengreen point out that the 2008 shock to the world economy was bigger than the 1929 shock. ... The nonfarm unemployment rate didn’t get anywhere near the 28% of the great depression, it didn’t get anywhere near the 16 or 17% that Allan Blinder and Mark Zandi calculate would have been the peak unemployment rate had the government followed ineffective and counterproductive Herbert Hoover policies.
I think that if you could go to Tim Geithner get him to tell you what he thinks, he would say that a 10% unemployment peak is not a good thing but it is not 17%, and it is definitely not 28%. He would say that he and his peers have done a lot better job at handling this than their predecessors 80 years ago did handling their problem.
And he would be right.
But now we have a stubbornly persistent slump in the economy..., with very little signs of closing the gap between the productive capacity of the American economy and its current level of production. We have a Washington DC that is dysfunctional--out of ammunition to take any effective additional steps to boost the economy. There is now substantial fear of inflation--even though there are no signs of inflation gathering anywhere... There is now substantial fear of crowding out--that boosting US government spending or cutting taxes to get more money into the hands of the consumers would discourage private investment even though there are no signs of crowding... It is a fact that a bunch of us--including me--think that there really should be signs of crowding out right now--that financial markets should be scared of the fiscal future of America--but they are not. And there is the problem that Washington DC has degenerated into pure Dingbat Kabuki theater on lots of levels. ...
But the biggest problem generated by this right now is that Washington DC's focus on the Dingbat Kabuki theater of the long-run fiscal stability of America is keeping it from taking any effective steps to use government to boost employment and output now. And things aren't helped by the fact that the way the rescue of the banking system was carried out convinced a lot of people that stimulus policies exist to enrich the top 1% of Americans at the expense of everybody else.
This means that our hopes for economic recovery right now rest not on any government boost to aggregate demand--whether through fiscal, monetary, or banking policy--but rather on the natural equilibrium-restoring full-employment achieving market forces of the economy, especially in the labor market.
And so we are in trouble: right now there are no signs that the economy is crawling up back to anything like full employment on its own. ... The economy will grow, but we won’t close the gap between actual and potential output. We will not for a long time to come get back to the 62 to 64% of the adult population having jobs that we thought was normal back in the decades of the 2000.
And that is the depressing overall macroeconomic picture. I wish I could paint a better one. ...

    Posted by on Sunday, May 22, 2011 at 10:08 AM in Economics | Permalink  Comments (19)


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