Macroeconomic Policy and the Current Depression--Posner
Macroeconomic Policy and the Current Depression‚ÄîPosner
I am not a macroeconomist, but given the strange, perhaps embarrassed silence of so many macroeconomists, mentioned by Becker, I feel less daunted by my lack of expertise than I ordinarily would be.
As Becker explains, the focus of central banks, such as the Federal Reserve Board, has been on maintaining price stability by reducing interest rates when economic growth is too sluggish and raising them when it is too fast. The first response encourages economic activity when needed and the second limits inflation. But control of interest rates cannot prevent depressions, including severe depressions. Nor can fiscal policy--government spending and taxing.
There appear to be three types of depression (why that word has been displaced by "recession" eludes me--who is supposed to be fooled by such a euphemism?). In one, the least interesting and usually the least serious, some unanticipated shock, external to the ordinary workings of the market, disrupts the market equilibrium; the oil-price surges of the early and then the late 1970s are illustrative. The second, illustrated by the depression of the early 1980s, in which unemployment exceeded 10 percent for a time during 1982, is the induced depression: the Federal Reserve Board broke what was becoming a chronic high rate of inflation by an unexpectedly steep increase in interest rates, which shocked the economy. In neither type of depression is anyone at fault, and the second was downright beneficial to the economy.
In the third and most interesting type of depression, illustrated by both the depression of the 1930s and the current depression, the cause is the bursting of an investment bubble. There was a stock market bubble in the 1920s fueled by buying stock with money loaned by banks. That was risky lending and as a result the bursting of the stock market bubble in 1929 resulted in bank insolvencies. The severity of the depression may have been due to the Federal Reserve Board's failure to bail out the banks, but the depression itself was due to the stock bubble's bursting and precipitating bank insolvencies. There was a lesser stock market bubble, in stocks of high-tech companies, in the late 1990s, but its bursting had a small effect on the economy as a whole.
The current depression is similarly the consequence, but a very grave one, of the bursting of a bubble. The bubble started in housing, but extended to commercial real estate and other sectors of the economy as well. Very low interest rates, imaginative marketing of houses (and of mortgages on houses) and other goods, and the deregulation of the banking industry spurred highly speculative investing; and the eventual bursting of the bubble, as in 1929, precipitated widespread bank insolvencies and a rapid and steep decline in the stock market, though this time the insolvencies preceded and precipitated the stock decline, rather than vice versa.
An article by Massimo Guidolin and Elizabeth A. La Jeunesse published a year ago in the Review of the St. Louis Federal Reserve Bank noted that the personal savings rate of Americans had actually turned negative, meaning that people were spending more than they were earning. And now such savings as people had, being heavily invested in the stock market, have become depleted by the drop in the stock market. As a result of their inadequate savings, people who lose their jobs or cannot sell the houses they no longer can afford are limited in their ability to reallocate savings to consumption, as they had done in previous, milder depressions. So consumption has fallen steeply, precipitating layoffs that have further reduced consumption (because the unemployed have lower incomes), creating the downward spiral that the economy finds itself in at this writing. And the timing could not be worse: during a presidential transition, with the lame-duck President seeming uninterested in and uninformed about economic matters, with economic officials whose stumbling responses to the gathering financial crisis have undermined their credibility, and with the crisis accelerating during the Christmas shopping system, which normally accounts for as much as 40 percent of annual retail sales. The buying binge financed by the heavy borrowing during the bubble have left consumers awash in consumer durables, so it is easy for them to postpone buying. Moreover, consumer durables are more durable than they used to be, so that replacement can be deferred longer than used to be possible.
If this diagnosis is correct, then the public-works expenditure program that President-elect Obama is proposing, though anathema to economic libertarians, resisted by the Bush Administration, and bound to be wasteful, as all such programs are, may be the most sensible response to the depression and one clearly superior to a tax cut. A tax cut or rebate, like the bank bailout, is unlikely, unless very large or credibly promised to be permanent, to stimulate consumption greatly; most of the money is likely to be used to rebuild savings or, in the case of the banks, to rebuild their equity cushion so that they can make loans, bound to be risky in a depressed economy, without courting bankruptcy. In other words, to stimulate economic activity the government will have to step in and ‚Äúconsume,‚Äù in lieu of reluctant or impoverished consumers by spending money on road repair and other public goods. A critical variable, however, is the length of time it will take for public-works projects actually to be begun. American government tends to be extremely sluggish.