Friday, June 25, 2010

Double Dip a Done Deal. D'Oh!

-- Posted by Neil H. Buchanan

Let me begin with a sincere (but resigned), "I hope I'm wrong." Economic forecasting is a dangerous business, especially for someone who is a natural pessimist. To adapt an old joke, I have successfully predicted nine out of the last two recessions. Even so, all of the pieces now seem to be in place for what we have feared all along: a policy-induced relapse into a second bout of recession, without ever having emerged from the Great Recession. In this post, I will explain why this sorry outcome now seems inevitable, what could be done to stop it, and what should be done after we fail to stop it.

Although there has been some encouraging news about the economy over the last few months (e.g., auto companies skipping their summer shutdowns), there is no question that the situation is still quite bad. The unemployment rate still hovers just below 10%, with the real rate of involuntary idleness well above that. Even so, given that unemployment is a lagging indicator (and taking account of oddities like the measured unemployment rate rising briefly in the face of optimistic economic news, with suddenly-encouraged workers flooding back into the job market), it might have been possible to argue that the economy will continue to recover and ultimately bring jobs back with it.

Maybe. Even the CBO's forecasts, however, predict that unemployment will stay above 8% through the end of 2012. Eight percent! Even in the 1980's, before we experienced years of unemployment in the 4-5% range, Reagan's apologists would only dare suggest that 6-6.5% was the "natural" rate of unemployment. This is, in other words, already a situation in which we have been told to expect years of above-normal joblessness, leading to economic and human damage not seen since the 1930's. Moreover, much of the rest of the economy seems already to be moving in the wrong direction. Earlier this week, for example, we learned that the economically-essential housing sector has never been weaker, with the lowest rate of new home sales on record.

In the face of that (at best) mixed picture, what is happening to economic policy? The Fed has announced that it is standing pat on monetary policy. Chairman Bernanke has admitted that he thinks that the economy is weakening and should be given some serious monetary stimulus. but he and his colleagues are afraid to "spook the markets." (Paul Krugman's columns over the past few months have included some especially trenchant observations regarding the bizarre logic of catering to hypothetical financial market jitters.) Fiscal policy is a disaster. Last year's much-too-timid stimulus will soon run out, with "centrist" Democrats (and, of course, all Republicans) refusing to do anything serious now.

Yesterday, all of the Senate's Republicans (plus Ben Nelson of Nebraska) blocked a bill extending unemployment benefits to 1.2 million long-term unemployed citizens, along with aid to states and cities that is necessary to forestall laying off hundreds of thousands of teachers, police officers, and other essential government workers. Even if (as is likely) some kind of compromise is reached on the extension of unemployment benefits, the amounts have already been reduced. Moreover, with the Fall elections a bit more than four months away, the opposition party has clearly decided that it is better politically to oppose all spending proposals going forward.

As insane as all of that is, the politicians in other countries seem to be even crazier. The new government in the UK has announced across-the-board 25% cuts in government spending. The German government takes pride in refusing to respond to recession with stimulative policies, in a sort of Protestant-ethic-meets-masochism celebration of self-imposed damage. Being part of the euro zone has forced many countries to adopt drastic measures to cut spending and raise taxes, even in the face of unemployment rates reaching into the 20% range.

In short, there is no prospect of help from consumers (who are scared of losing their jobs, or who have lost them already and will soon have reduced or nonexistent income support), business investment (because no sensible business would spend money to expand in this economy), government spending ("cut the deficit!"), or exports (notwithstanding China's mild moves toward adjusting its currency).

What could we be doing? President Obama surprised me recently by trying to convince other world leaders to stop enacting self-destructive policies, but his timidity and tardiness on the issue is now coming back to haunt him (and the rest of us). Really, there is no mystery about what we could or should be doing. Reverse course on fiscal and monetary policy. Make job creation the central goal of economic policy. Educate the public about the important of increasing deficits during bad economic times. Save states and cities from fiscal implosion.

We will not, of course, do any of that -- at least, not until things turn very ugly once again (and maybe not even then). If the ensuing crash does not lead to, in the sinister words of a current U.S. Senate candidate, "second amendment-type solutions" -- in which case we will have much bigger things to worry about than spooking financial markets -- then we will have to dig out of an even bigger hole. That will require even more deficit spending, of course.

I wish I could end on a joke. I cannot. Again, I really hope that I am wrong.


egarber said...

One thing to throw out there.

Unlike in other downturns, corporate finances are generally very strong right now, which signals to me that companies are sitting on a lot of cash. So whereas the initial crisis was deep, because the entire credit system had dried up, right now I keep coming back to the image of my dog when we come home after a long day; all of her pent up energy explodes at once when we let her out back.

Leaving aside the fiscal policy dimension, we are about to hit a phase of greater certainty in the regulatory arena. Just last night agreement was reached on financial regulation -- and healthcare is an afterthought at this point. That removes another barrier to expansion.

Maybe I'm just being optimistic, but it seems to me the core pieces are there for a rebound. The slack is continuing to drain from the system, and at some point, companies that can hire won't have much choice but to make both capital and labor investments. It won't be the equivalent of my psycho dog's energy :), but it could mean positive energy.

As an aside, it's interesting how a key point gets lost in all the deficit debate: the end of stimulus spending itself will cause a significant downward shift in yearly deficit financing. This is always left out when pundits claim that the current deficit level is a permanent fixture. I know the more subtle long-term projections account for this, but the folks screaming the loudest are doing their own math on this stuff.

Neil H. Buchanan said...

I appreciate the attempt at optimism. There is something to this, but there is also a reason that businesses are sitting on cash rather than investing it: There's no reason to invest in plant or equipment right now! Even a psycho dog will not run out into a yard that scares her.

The sad thing is that the best way to encourage businesses to start spending would be to increase deficit spending. My dissertation included an analysis of historical US data, confirming that there is a powerful "crowding in" effect when the government kick-starts the economy. Businesses need to see potential customers before they expand. The federal government alone is able to set that process in motion.

Charles said...

Ignoring for the moment macro/technical arguments pro and con prospects for a brighter economic future, my continuing micro/non-technical questions are:

Given that a huge amount of phony wealth (and the attendant devil-may-care psychology) has been permanently removed from the economy (see note below), why would anyone think that there are not large numbers of people who have suffered significant long-term adverse changes that make the prospects for their economic futures bleak indeed?

And given that those people used to be consumers and that large numbers of people who have been less adversely affected but have nonetheless "seen the light" and are restraining their consumption, why would anyone think that previous levels of PCE will return in the foreseeable future? (Again, see note below.)

One obvious answer is that the impacts of the economic collapse have been distributed quite non-uniformly. For example, among the people I deal with (who span the whole non-poor spectrum), the impacts have been minimal to non-existent with but one exception - and the impact on that person has been, and almost certainly will continue to be, devastating. Perhaps too many economic forecasters are members of the former group rather than among the exceptions, and are afflicted per the currently popular quip: it's hard to see that which one's livelihood depends on not seeing.

Returning to macro/technical arguments, a large dose of skepticism about their predictive efficacy seems appropriate given their track record re the late 90s stock market bubble and the recent housing market bubble and economic collapse. Eg, well into 2008 (as best I recall), GDP and stock market performance misled people, so I see no reason to assume that recent "evidence of recovery" - especially given distortions due to various "recovery" programs - should give rise to much optimism. So, it seems that caution and compassion should be the principle drivers of near-term policy. Whether the former dictates greater or lesser stimulus is beyond my ken, but I'm pretty sure the latter is not evidenced by playing politics with expiring unemployment benefits.


Not to suggest that these will never return, only that future increases will have to be created, not recovered (as suggested by the euphemistic "economic recovery").

Neil H. Buchanan said...

Charles is quite right that I should be understood to use the term "economic recovery" not to mean "going back to the way things were pre-2008" but "bringing the economy back to something like 'full employment.'" This must be done based on something more sustainable and substantial than the paper wealth that the housing bubble created (and then wiped out).

Even though there are a lot of people whose life prospects have changed, and even though they (and many other people) will not be consuming as much as they used to on a percentage-of-income basis, there is no reason that the economy cannot move back to the 4-5% range of unemployment and annual GDP growth rates averaging in the 3% range. The more we help people whose basic consumption needs are unmet (aka, the unemployed), the more we show compassion and set the stage for longer-term growth and stability (both economic and social).

Charles said...

Neil -

Although I now see that it wasn't clear, my "rant" was motivated by, but not directly in response to, your post. As usual, I agree with the most or all of your commentary.

And I agree that we might well "recover" long-term to acceptable levels of key indicators after an overhaul of the economy that eliminates dependence on unsustainable levels of consumption and debt, but evidence of serious intent to undertake such an overhaul escapes me. I too hope I'm just missing it.