Patrick Lane writes:
Economist Debates: Keynesian principles: One of our floor speakers, UnarmingMermaid, is quite right. Taking the motion at face value, there is no debate at all. Brad DeLong and Luigi Zingales agree: as a matter of plain fact, we are not all Keynesians now. The dispute is about whether we—or rather, economists and policymakers—should be. For Mr DeLong, the answer is an unequivocal yes. The seizing up of the banking system means that finance is no longer flowing to businesses. That means that increasing numbers of people are being left idle and without a wage. Unnecessarily so: the government, unlike businesses, can borrow cheaply, and should use its borrowing and spending capacity to put people back to work. Mr Zingales points out that economists usually require evidence of market failure before recommending that governments step in. He sees no compelling reason, in theory or practice, for a government spending splurge. That does not mean that the government should do nothing. But it should concentrate instead on fixing a failure in the housing market and on dealing with the banks...
I cannot help but think that Luigi Zingales is at least six months out of date...
There are three important things going on:
A mortgage finance crisis, costing the world about $2 trillion in mortgages that will not be repaid (which is, however, offset by the fact that those who are about to default on their mortgages have received about $1 trillion in privately provided housing subsidies that they never paid for). This crisis was caused to some degree by overly lax regulation, to a greater degree by failures of financial corporate governance, and to the greatest degree by irrational exuberance. We should clean up after this crisis and think hard about how to regulate markets so things like it don't occur in the future.
A shadow banking system crisis turned into a full banking system crisis, costing the world about $30 trillion in lost wealth (most of which, however, will reappear when risk tolerances return to normal levels or will accrue in long-run return bonanzas to patient capital that buys assets and current fire-sale prices and holds them to maturity). This crisis was triggered by the mortgage finance crisis and by excessive leverage and inadquate risk controls (but not, as I see it, by gross additional failures of corporate governance). We need to deal with this crisis by fixing the banking system--but we should not expect to see much additional private sector lending for business expansion to come out of the financial sector for the next two years even if we do successfully fix this crisis today.
An aggregate demand crisis as businesses that ought to be expanding find that they cannot obtain financing on terms that make expansion profitable, and hence cut back on their spending and hiring--and the workers they do not hire cut back on their spending in turn. This crisis has already hit a net of 7 million workers in the United States, 8 million in western Europe, and perhaps 30 million additional worldwide. We need to deal with this crisis as well by ramping up government spending to cushion the enormous rising tide of joblessness.
The important thing to note about these three crises is that they are three different things. They require different cures--and curing one does not do much to help or hurt efforts to cure either of the others.
Luigi Zingales appears to live in a world in which (1) and (2) have happened but (3) has not. That is the world we lived in last July. That is not the world we live in now. Hence what he hazs to say is of very limited relevance to our present predicament.