Is this really a replay of the Great Depression?
Professor Garett Jones
Garett Jones: So far, it looks like a junior version
of it — a bubble collapses, and that cripples the balance sheets of
otherwise healthy firms and banks. Anybody in this economy who borrowed a lot
of money based on the belief that home prices would never fall is in a lot of
trouble. Of course, nobody thinks the economy is going to decline by 25 percent
as it did during the Depression. Part of what made the Great Depression “great”
was the failure of the Federal Reserve to respond aggressively: it let the
money supply fall by a third. This time, the Fed has been incredibly
responsive: monetary supply grew 10 percent over the past year. Money growth
takes a year or two to help the economy, but help is already on the way.
Menzie Chinn: I think the problems of recapitalizing
and repairing the financial system are more intractable than during the Great
Depression and early 1990s credit crunch. Furthermore, there is a synchronized
aspect in the global downturn which adds extra headwinds. That’s why,
in terms of output loss and duration, this recession will easily rival that of
the 1980-82 recessions.
What do you like and dislike about the stimulus package?
Professor Menzie Chinn
Chinn: What’s good is that it exists, and
that there are some transfers of resources to states. Given how strapped the
states are for funds, they will spend a big chunk of it, although there could
have been a bigger bang for the buck had we given them more. What’s
not so good is that compared to earlier versions, the bill President Obama
signed relies more on tax cuts and tax rebates and less on spending. But it’s
not clear this is an effective way to stimulate the economy, since given the
level of uncertainty, middle- and upper-income people will save a lot of their
tax cuts, so you don’t get as big a “multiplier effect.”
[Editor’s note: The great 20th century economist John Maynard
Keynes argued that each dollar the government injects into the economy creates
multiple dollars’ worth of output. To simplify: Uncle Sam pays $100
to a biofuels engineer, who spends part of it at a car dealership, who then
spends part of that sum on new carpets for his showroom, and so on.]
Jones: What’s good is the direct aid to
people who are suffering ― food stamps, unemployment insurance, maybe the
Cobra subsidies. What’s not so good are the poorly targeted spending
programs: the infrastructure spending and the green spending. Few of the people
hired for these jobs will be pulled out of long-term unemployment; they’ll
mostly be moving from the private sector to some government contractor.
If the bill had focused on hiring West Coast construction
workers and East Coast bankers, then they would’ve found a lot of
unemployed people to hire. But Congress didn’t do that. Instead, they’re
spending more on low unemployment sectors like science, education, and health
care. It’s almost like they designed it to crowd out the private
Chinn: If the economy were at or near full
employment, you could make that argument. But I suspect that for the next 18
months, there is going to be a lot of underutilized resources. The likelihood of
crowding out is small.
Is there a risk that the stimulus plan replicates Japan’s
mistakes of the 1990s?
Jones: Yes, there is. Just like in Japan, the
stimulus spending takes our eye off the main issue — the crippled
banks. Good Keynesianism helps the private sector heal itself through money
growth, temporary tax incentives, and automatic, depoliticized spending like
unemployment insurance. But in Japan, bad Keynesianism simply shifted hundreds
of thousands of workers into the government-funded construction industry.
Chinn: There’s a benefit to having people
working on infrastructure that arguably could have a high social rate of return.
I’m thinking of things like the national parks lodges built during
the Depression. That might not have been efficient spending, but we are glad to
have them 80 years later.
I also think there is a problem with the analogy. Japan did
two things in the 1990s. One was a massive stimulus that increased the national
debt, and a lot of it was not very efficient. The other was that they failed to
take care of their financial system in decisive fashion. The technocrats knew
what the solution was, but the politicians were not willing to inject
sufficient taxpayer money into the system. For the U.S., the big danger I see
is that we don’t bite the bullet and fix the system —
including letting some banks go under — and make sure it’s
well regulated afterward.
What are the chances we will do the right thing?
Chinn: I’d say better than 50-50.
Jones: I’d have hoped for better than 50-50
out of the best and the brightest. So far, the U.S. technocrats have followed
the same policy as the Japanese: they’re keeping the zombie banks
alive with government support. There’s no need for that. The biggest
banks have $1 trillion in long-term debt sitting on their balance sheets, debt
that could be effortlessly converted into stock with the pounding of a
bankruptcy judge’s gavel. That debt-to-equity “cram down”
would give the big banks thick layers of equity that would restore trust and
reinvigorate lending. President Obama’s technocrats haven’t
yet been willing to do that. Here’s hoping they change their minds.
Chinn: Well, let’s be frank. The problems
left over from the past eight years of incredibly bad economic management are
weighting the odds against us. So my better than 50-50 assessment is testament
to the high regard I have for the technocrats in the Obama administration.
Some argue that stimulating the economy when employment
is falling is not something the private or public sector
can do effectively. What do you think?
Jones: Again, Japan is a great example. One of the
big insights of modern unemployment research is that hiring workers or
searching for a job is a lot like dating: it just takes a long time to find a
good match. If we have stadium-style mass weddings, yes, we’ll raise
the number of married couples, but we’ll probably create a lot of bad
matches. The same is true in the job market, whether it’s the
government or the private sector that’s doing the hiring.
If our goal is just to have an excuse to send checks to
people who are suffering, then maybe the government needs to create a lot of
these “mass weddings.” But if our goal is to get some
actual value out of the new workers, it’ll take a long time to ramp
up. And during all that ramp-up time, we could’ve been helping the
private sector heal itself through bank restructuring.
Chinn: As I see it, any spending is going to help.
Also, it’s not clear to me that the stimulus plan will have the
spending come in too late. Around 70 percent of the spending will occur within
the next 18 months. Given that most forecasters are projecting a long
recession, the fiscal stimulus will still be timely.
Jones: It’s just not true that any spending
is going to help. If $1 of government spending only creates $1 of extra output,
then that spending needs to be genuinely valuable — especially when
we consider that future generations will be paying for this spending with
wealth-destroying taxes. Now if $1 of government spending creates $2 or $3 of
extra output during a recession, then Menzie’s absolutely right: that
would set off a virtuous cycle of consumer spending. But the best historical
evidence doesn’t support these big multiplier effects.
Are we all Keynesians now?
Chinn: No, but there are a lot more than there were a
year ago, including among academic economists.
Jones: When the financial crisis hit, many academic
economists panicked, and they retreated to the most primitive, freshman-level
Keynesianism imaginable. I’m hoping that over the next year our
profession recovers from that panic and remembers the better side of
Keynes recognized two big facts: that market economies can
twist themselves into short-run knots, and that the mechanisms for untying them
are clunky and cumbersome. He spent his later years trying to find ways for
government to help the private sector untie those knots without just creating
new, tighter ones. Keynes concluded that public works programs were a bad kind
of stimulus: they usually come too late, after the economy would’ve
fixed itself anyway, and it encouraged politicians to manipulate things. A Keynesianism
that helps the private sector heal itself is a Keynesianism we should all
Chinn: The private sector can heal itself eventually.
But it may take a very long time to work its way through, and I doubt that
modern societies can bear that long a wait.