“[…]Consider, for example, the following summary of economic conditions: (1) Signs indicate that the recession is finally over. (2) Short-term interest rates have been close to zero for years but are now expected to rise. (3) Some are concerned about excessive inflation. (4) Inflation concerns are partly driven by a large expansion in the monetary base in recent years and by banks’ massive holding of excess reserves. (5) Furthermore, some are worried that the recent rally in commodity prices threatens to ignite an inflation spiral.”
That sounds like a pretty good description of the current economic situation. However, it is not. That quote is actually from a December 2006 article in the Journal of Monetary and Economic Studies by Gauti Eggertsson of the Federal Reserve Board of New York and Benjamin Pugsley of the University of Chicago.
Obviously they are not talking about the current economic situation. What they were describing was the economic situation in early 1937. Here is the article if you want to read it (but fair warning, it is as dry and technical as implied by the journal it was published in).
1937: A Huge Economic Mistake Was Made
That is a very significant date in that it was just before one of the biggest economic policy mistakes of all-time: the decision to cut back on fiscal stimulus to try to balance the budget, and to raise interest rates and tighten up on monetary policy to head off inflation. That was what caused a very sharp recession to start in the middle of 1937, a recession that was not ended until WWII got underway.
The retreat from the New Deal undid much of the good that it initially did. It also gave rise to the (false) claim that the New Deal didn’t end the Depression, WWII did. For starters, FDR’s first term had the highest peacetime rate of growth in both GDP and Industrial Production the country has ever seen (although the data is very thin for the 1930’s and practically non-existent before the 1930’s). Unfortunately, the GDP data is only available on an annual basis for the 1930’s, and other key data only goes back to the post-war period.
I would also point out that in economic terms, WWII was macroeconomic stimulus on steroids. It was the use of government money — borrowed money at that — to buy massive amounts of things like steel and to put people to work (OK, so the work outfit was a uniform rather than a suit and tie). Economically though we would have been much better off it that steel were still bought and used to build bridges rather than just sinking that steel to the bottom of the Atlantic, as was often the case during the war.
Long-Term Trends
Regular readers of my posts know that I am somewhat obsessed with looking at the long-term trends. If the data is available, I rarely produce a graph with less than 30 years worth of data on it. I do this because I take Santayana’s famous maxim “those who do not learn from history are doomed to repeat it" to heart. It might also just stem from the fact I was a History and Political Science major in my undergrad work.
I am afraid that right now, Washington is determined to forget about history. Even though unemployment is at extremely high levels, and has been for a very long period of time, the entire policy discussion is about doing things that will have the inevitable effect of slowing down the economy.
Those things — like sharply slowing down Federal spending and unwinding the accommodative monetary policy — would be good things to do if the economy were overheating and inflation were the main economic worry. It is not, or it should not be in a sane world.
The bond market is convinced that inflation is not going to be a big problem. How else could you possibly explain a desire to lend to the U.S. government at a rate of just 3% for ten years? Does anyone think that the Chinese and domestic institutional investors are charitable institutions that are just looking to lose money in real terms?
Inflation is running much lower than it has been for most of the last 40 years. In terms of core inflation, it is running at near-record lows. With unemployment running at 9.0% (and based on today’s ADP numbers; it will probably rise in with Friday’s report) it is very hard to see how a wage price spiral will break out. Yes, headline inflation has been headed higher, but prices at the pump have already fallen back a bit, so it will most likely be tame in May and June.
Still Under Shadow of Great Recession
It is not just that unemployment is high, but the level of long-term joblessness is extremely high. The Great Recession has simply shattered the old records in terms of the number of people out of work for more than six months, both in absolute numbers and as a share of the total unemployed.
Long-term joblessness is a much more serious problem than short-term joblessness. It is not just an unplanned vacation, it is an existential threat to those people’s long-term financial well being.
There are millions of people out there now who have not only run through the normal 26 weeks of unemployment insurance, they have exhausted the extended benefits paid by the Federal government (the "99ers"). Once, those people might have had houses and cars and even 401-k accounts; now they are becoming destitute. Unfortunately, the long-term unemployed are just about the last people who will donate to political campaigns, and thus the politicians think they can safely be ignored.
The imbalances leading up to the Great Recession were as large, if not larger, as those leading up to the Great Depression. The key reason we are not in another Great Depression is because this time around the government acted much more promptly to backstop the banks and to provide some fiscal stimulus.
While it is easy to find fault with the actions of the Federal Reserve in the lead-up to the 2008 crisis, they did a very good job when the crisis hit. Bernanke, a leading scholar of the causes of the Great Depression, did not forget history and immediately moved to slash short-term rates to near zero and to provide liquidity to the system.
The TARP program, while far too generous in its terms (the yield on the preferred stock should have been twice what the taxpayers got, and we should have received far more warrants) proved to be a success. The banking system did not fall apart, and the final cost of the program is going to be a very small fraction of the initial $700 billion price tag (actually, at no point was there close to $700 billion outstanding). The government might even wind up making a small “profit” on the transaction.
The fiscal stimulus in the ARRA proved to be just enough (along with the monetary stimulus) to halt the downward slide in the economy, but not enough to really fuel a recovery. That is exactly the result I was predicting at the time it was passed. However, back then I was more hopeful that there would be more bites at the apple to get the economy moving again.
The ARRA has largely run its course, and there is no hope that we will have a “son of ARRA.” Indeed, the discussion in DC is all about how fast we should go down the path we went down in 1937. We are already starting to feel the effects of our journey down that path in the weak data we got this morning from the ADP employment report and the ISM manufacturing survey. Those are not isolated data points, but part of a wider trend of soft data over the two months or so.
I am getting increasingly concerned that the economy just can’t withstand more austerity. It looks like we soon will be facing the choice of an immediate implosion of the economy — in the form of a failure to raise the debt ceiling, or a slow drip of the repeat of 1937. Unfortunately, either would be a self-inflicted wound. Unfortunately DC seems determined to ignore history, and shoot not only itself, but the U.S. economy in the foot.
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