In my first book on the economic crisis (A Failure of Capitalism: The Crisis of ’08 and the Descent into Depression), which was completed in February 2009, I argued that the crisis should be called a depression rather than a recession, in part because of the enormous debts that the government was assuming in an effort to overcome the crisis. In my second book (The Crisis of Capitalist Democracy), completed in January of this year, I further emphasized the potential long-term adverse consequences of the crisis, and argued that a depression or recession should not be considered over until GDP rejoins its growth path. GDP in real terms is essentially unchanged from what it was two and a half years ago (2007), which means it’s roughly 7.5 percent below the growth path (which assumes 3 percent real growth annually), and suggests that it will be years before the economy gets back on it.
I continue to insist that this is the proper way to evaluate an economic crisis. Most journalists and many economists believe that the “recession” as they like to call it (or “Great Recession”—indicative of a mindless proliferation of labels) ended in the third quarter of 2009, when GDP began to increase, after having been flat in 2008 (though falling sharply in the last quarter) and falling in the first half of 2009. But the current performance of the economy, and the likely political and long-term economic consequences, convince me that we are in the midst of a depression, much as we were in 1936 (before a sharp drop in 1937–1938), even though the economy had grown rapidly since the bottom of the depression in 1933.
Why is the economy so sluggish at present? The basic reasons are, I think, first, the reduction in household wealth, due to the fall in housing and common stock values (with the fall in housing values precipitating many foreclosures); second, the high rate of unemployment, underemployment, and reductions in wages and benefits; and third the continued weakness of the banks.
The reduction in household wealth increased the amount of leverage (debt-equity ratio) in consumers’ personal finances, and consumers have been deleveraging by increasing their personal savings rate (which has increased from 1.7 percent three years ago to 6.4 percent today), leaving them with less money for consumption. One might think that today’s very low interest rates would discourage savings, but the other side of this coin is that savers must increase the amount of their savings in order to obtain the interest income they obtained when interest rates were higher.
With less consumption, there is less production and hence less private investment. These effects are being compounded by the weakness of the labor market from the perspective of workers, which reduces incomes and, by increasing insecurity, increases the propensity to save. And while banks are making good profits because of the very low interest rates at which they can borrow, they continue to hold many sick assets (mainly investments in home and commercial mortgages) on their books, making them reluctant to lend. And anyway loan demand is way down. Most borrowers from banks are either small business or consumers (large businesses tend to borrow by issuing bonds or commercial paper rather than by taking out banks loans), and neither group is in the mood for increasing its indebtedness.
One spur to recovery from a depression is the need to rebuild inventories and replace durable goods that have worn out. This need may explain, along with the stimulus program enacted in February 2009, the growth in GDP that began in the third quarter of 2009 and seems now to be fading. As long as demand for consumption goods is weak, sales will slow after inventories are restocked and worn-out durable goods are replaced. Modern products tend to be highly durable and inventories tend to be much smaller than they used to be, so one cannot expect these standard spurs to economic recovery to have much staying power.
The uncertainties and long-term debt created by the Obama Administration excessively ambitious domestic programs (notably health care and financial regulatory reform) on top of the deficit spending of the Bush years, the plunge in federal tax revenues resulting from the depression-induced decline in taxable income, and uncertainty about which Bush tax cuts will be allowed to expire in the coming year, have impeded private investment. They have done this by exacerbating concerns about what the economic picture will look like both in general and for individual businesses and consumers in the next several years, and perhaps much longer.
A further worry is the volatility of the stock market. The tendency is to view the market’s gyrations as reflections of changing estimates of future corporate earnings and of efforts by investors in the market to guess what other investors are likely to do. But when as at present a large fraction of the population has a significant part of its savings invested in the stock market, market volatility increases economic anxieties and thus dampens spending.
As long as private investment and interest rates remain very low, there is a case for further stimulus (deficit spending), especially since federal stimulus spending has been offset to a degree by reductions in state and local government spending. Cautious or fearful consumers save in safe forms, such as insured bank deposits, Treasury bills, or cash. Such savings are inert; under present conditions they do not get translated into productive investment, since banks are reluctant to lend but instead keep most of the deposits they receive in either cash or government securities. The government, to whom no one is afraid to lend, could put all these inert savings to work on infrastructure and other projects that would employ the unemployed.
That is in principle, but because the Obama Administration botched the design, execution, and public relations of the $862 billion stimulus program (President Obama, despite his undoubted eloquence and intelligence, has proved to be a poor explainer of his economic policies), and because of the soaring public debt (to which the stimulus contributed), there is no political stomach for a further stimulus of any consequence.
What is to be done? With Congress in recess and the mid-term elections looming, probably very little. The best hope may be that the President’s bipartisan deficit commission (the National Commission on Fiscal Responsibility and Reform) will issue a first-rate report. (Its report is due December 1.) If the commission, chaired by President Clinton’s chief of staff, Erskine Bowles, and former Republican Senator Alan Simpson, produces an economically sound and politically palatable program for restoring the nation’s long-term fiscal soundness—a program to which far-reaching tax reform will be central—this may alleviate economic uncertainty and encourage more consumption and private investment in the near term.