David Wessel Says: It Is 1931 Again
David Wessel:
The Perils of Ignoring History: There is an optimistic scenario for the U.S. economy: Europe gets its act together. The pace of world growth quickens, igniting demand for U.S. exports. American politicians agree to a credible compromise that gives the economy a fiscal boost now and restrains deficits later. The housing market turns up. Relieved businesses hire. Relieved consumers spend. But there are at least two unpleasant scenarios: One is that Europe becomes the epicenter of a financial earthquake on the scale of the crash of 1929 or Lehman Brothers 2008. The other is that Europe muddles through, but the U.S. stagnates for another five years, mired in slow growth, high unemployment and ugly politics…. No one would intentionally choose the second or third, yet policy makers look more likely to stumble into one of those holes than find a path to the happier ending.
Why? Liaquat Ahamed has been pondering that question…. "Is it because people don't know what to do (or there's disagreement about what to do)," he wonders, "or is it the politics, particularly the reluctance to ask some people to pay for the mistakes of others?" "In the '20s," he says, "there was much more ignorance"—the disastrous fealty to the gold standard, the Federal Reserve's failure to understand its role as lender of last resort. Today? Mr. Ahamed can't decide if it's ignorance or insurmountable political barriers that keep governments from doing what needs to be done.
In the 1920s, two crises fed on each other: a banking crisis in the U.S. and a sovereign-debt crisis in Europe. (Sound familiar?) In our time, the U.S. handled its banking crisis better than it did back then. (Yes, much better, despite missteps and criticism.) But Europe? The problems go well beyond the inevitable Greek default on its debts. "We are discussing a broken ankle in the presence of organ failure," Lawrence Summers, the former U.S. Treasury secretary, quipped last week about the fixation on Greece….
Mr. Ahamed sees another, largely unappreciated lesson from the '20s. The few moves in the right direction then were too small for the scale of the economic disaster. After 1929, the Fed did open the credit spigot—a bit. And Herbert Hoover did push through an increase in public-works spending and an income-tax cut, but they were small. In our time, says Mr. Ahamed, "I don't think Keynesians or even monetarists ever realized that the numbers to make their policies work are so gigantic. Everyone had sticker shock." The Obama stimulus seemed huge and the Fed's quantitative easing—printing money to buy bonds—looked massive, but in retrospect perhaps they weren't sufficiently large. To be sure, some advocates of the earlier fiscal and monetary stimulus, such as Harvard University's Robert Barro, doubt that another big dose now would do much good.
Today, political stalemates in Europe and the U.S. block both the short-term policies these economies need to avoid a return to recession and—importantly—also block the long-term course corrections required to get the economies growing faster in the future. Europe needs to avoid financial calamity now and to decide whether and how it will move toward economic and fiscal integration or less integration. It cannot stay where it is.
In the U.S., it's hard to see what will power the economy over the next couple of years. It won't be consumers, still laden with debt. It won't be housing. Exports are up, but overseas economies are slowing. Local, state and federal governments are retrenching. Small businesses can't get credit, and big businesses look at all of the above and won't hire….
A senior U.S. policy maker, a fan of Mr. Ahamed's book, called me the other day. "Promise me," he said, "that if you write a sequel about the Great Depression of 2012 that you'll note that I was one of the guys really trying to head it off." It was, in a way, one of the few encouraging things I've heard lately. It conveyed a welcome appreciation of how large the stakes are. We'd be better off if more policy makers realized that.
As best as I can see, Liaquat Ahamed's claim that "Keynesians or even monetarists ever realized that the numbers to make their policies work are so gigantic. Everyone had sticker shock…" is simply wrong. I know that I was talking in April 2008 about how we wanted to be ready to nationalize Fannie and Freddie and use them to refinance every single mortgage in the country if it should become necessary. Christina Romer and Jared Bernstein could do the math on the demand gap in late 2008 and early 2009, and did so.
The monetarists are harder. Some--Lars Svensson, Michael Woodford, and Scott Sumner comes immediately to mind--seem to have known well how much less effective open-market operations are once you hit the zero nominal bound, how large the scale of operations have to become, and how it is (we think) much better not to announce volumes of bond purchases but instead to try to engage stabilizing speculation on your side by announcing that you are targeting the forecast. Others did not seem to get it, and still do not seem to get it.
And I gotta protest David Wessel's claim that Robert Barro was an "advocate of the earlier fiscal and monetary stimulus". I remember Robert Barro in January 2009:
Robert J. Barro: Government Spending Is No Free Lunch: A much more plausible starting point is a multiplier of zero. In this case, the GDP is given, and a rise in government purchases requires an equal fall in the total of other parts of GDP -- consumption, investment and net exports. In other words, the social cost of one unit of additional government purchases is one…. [T]his perspective, not the supposed macroeconomic benefits from fiscal stimulus, is the right one to apply to the many new and expanded government programs that we are likely to see this year and next.
What do the data show about multipliers?… I have estimated that [in] World War II… the multiplier was 0.8…. There are reasons to believe that the war-based multiplier of 0.8 substantially overstates the multiplier that applies to peacetime government purchases….
I can understand various attempts to prop up the financial system. These efforts, akin to avoiding bank runs in prior periods, recognize that the social consequences of credit-market decisions extend well beyond the individuals and businesses making the decisions. But, in terms of fiscal-stimulus proposals, it would be unfortunate if the best Team Obama can offer is an unvarnished version of Keynes's 1936 "General Theory of Employment, Interest and Money." The financial crisis and possible depression do not invalidate everything we have learned about macroeconomics since 1936. Much more focus should be on incentives for people and businesses to invest, produce and work…. Eliminating the federal corporate income tax would be brilliant.
On the spending side, the main point is that we should not be considering massive public-works programs that do not pass muster from the perspective of cost-benefit analysis…
