Too few American officials recognise the need to boost demand: THE financial crisis is what went wrong with the American economy.
As Richard Koo would say—as he has said over and over and over again—the US economy looks as one would expect an economy to look in the aftermath of a financial crisis.
Households think—correctly—that they have too much risky debt and that they are too poor for the sum of household spending and business investment to add up to enough demand to attain full employment. Open-market operations don't help: they have no effect on household or business assets because they are simply swapping one zero-yield government asset for another. The risky debt that companies could issue does not sell in terms that make companies happy to expand investment—how can it when households already feel overextended and will only buy risky assets at an attractive price? The economy will recover only as rapidly as households rebuild their balance sheets and so become confident, spending more on the one hand and financing risky business investment on the other—and that can take a long time.
Credit-worthy governments acting aggressively could greatly speed recovery from such a balance-sheet recession. The economy has not too much debt but rather too much risky debt: safe debt right now sells at unbelievably high prices. Credit-worthy governments can boost demand directly by borrowing and spending. Credit-worthy governments can boost demand indirectly by taking on tail risk—either via guarantees or swaps of its debt for risky debt—on terms that make it attractive for businesses to borrow and invest. Aggressive central banks can shift expected inflation upward and thus make households fear holding risky debt and equity less because they gear dollar devaluation more.
The US government could undertake all of these strategies for dealing with a balance-sheet recession, and I am highly confident that at least one would work.
But it won't.
In the late spring of 2009, Barack Obama had five economic policy principals: Tim Geithner, who thought Obama had done enough to boost demand and needed to turn to long-run deficit reduction; Ben Bernanke, who thought that the Fed had done enough to boost demand and that the administration needed to turn to deficit reduction; Peter Orszag, who thought the administration needed to turn to deficit reduction immediately and could also use that process to pass (small) further stimulus; Larry Summers, who thought that long-run deficit reduction could wait until the recovery was well-established and that the administration needed to push for more demand stimulus; and Christina Romer, who thought that long-run deficit reduction should wait until the recovery was well-established and that the administration needed to push for much more demand stimulus.
Now Romer, Summers, and Orszag are gone. Their successors—Goolsbee, Sperling, and Lew—are extraordinary capable civil servants but are not nearly as loud policy voices and lack the substantive issue knowledge of their predecessors. The two who are left, Geithner and Bernanke, are the two who did not see the world as it was in mid-2009. And they do not seem to have recalibrated their beliefs about how the world works—they still think that they were right in mid-2009, or should have been right, or something.
I fear that they still do not see the situation as it really is.
And I do not see anyone in the American government serving as a counterbalance."