What Have We Learned from the Great Recession? J. Bradford DeLong U.C. Berkeley January 7, 2011
Five Things We Knew That Turned Out Not to Be True • Three years ago I, at least, thought that all of these were true:
– That the large highly-‐leveraged banks had control over their risks. – That the Federal Reserve had the power and the will to stabilize nominal GDP. – That as a result fiscal policy—automaUc stabilizers aside—no longer had a legiUmate countercyclical role to play. – That no advanced-‐country government with as frayed a safety net as America has would tolerate 10% unemployment. – That no maXer what theories they worked on, economists had an effecUve consensus that the government’s proper macroeconomic role was to intervene strategically in asset markets to stabilize nominal GDP.
• It turns out that none of them are true.
That the Large Highly-‐Leveraged Banks Had Control Over Their Risks • What I thought three years ago:
– American commercial banks hit the wall when the Volcker disinflaUon interacted with their petrodollar recycling. – American savings and loans had hit the wall when the KeaUng Five gave them the opportunity to gamble for resurrecUon. – Otherwise they had taken every shock the economy could throw at them and come through successfully: • • • • • •
The crash of 1987 Saddam Hussein’s invasion of Kuwait The LTCM crisis The Russian state bankruptcy Assorted EM crises The collapse of the dot-‐com bubble
– The large, persistent equity premium strongly suggested that financial markets lacked paUent risk-‐bearing capital. – Thus there was a strong argument that we needed more, not less leverage in our financial system—since risk-‐bearing appeared to be a scarce and valuable factor of producUon.
This Turned Out to Be Wrong • The highly-‐leveraged banks did not have control over their risks. • They did not even know what their risks were. • They appear to have genuinely thought that their underlings were following the originate-‐ and-‐distribute business models that they were supposed to. • And they had taken next to no steps to give their high-‐flyers incenUves to look out for the welfare of the firm.
That the Federal Reserve Had the Power and Will to Stabilize NGDP • What I thought three years ago: – That the Federal Reserve could stabilize nominal GDP: • Through helicopter drops, if necessary.
– That the Federal Reserve would stabilize nominal GDP: • The costs to the Federal Reserve’s standing and to its self-‐ percepUon would ensure that.
• This turned out not to be true: – That NGDP is 10% below its pre-‐2008 trend has not been of any great concern at the Federal Reserve. – That the FRB has not been staffed up has not been of any great concern to the White House
That DiscreUonary Fiscal Policy Had No LegiUmate Role • What I thought three years ago:
– The Federal Reserve has the power and the will to stabilize NGDP. – The Federal Reserve can act and affect the economy inside the congress’s decision-‐acUon loop. – DiscreUonary countercyclical fiscal policy thus has no role to play
• And has the potenUal to confuse people—congressmen and investors—about the long-‐term budget plan.
• This turns out not to be true:
– When the Federal Funds rate hits the zero lower bound, making monetary policy effecUve becomes... complex... – Government purchases then have a role to play as a form of spending that does not have to be backed up by money supply-‐balances—the government having the lowest spending-‐to-‐money-‐balances raUo of any enUty. – Government debt issue then has a role to play as a way of keeping open-‐market operaUons from offsedng themselves whenever money and debt are close subsUtutes.
That No American Government Would Tolerate 10% Unemployment • What I thought three years ago:
– American governments understood that high unemployment was social waste. – American governments understood that high unemployment was very hazardous to incumbents. – American governments simply would not tolerate 10% unemployment.
• It turns out that none of these are true:
– Why? – I had five theories: union collapse; Washington disconnecUon; public scorn at the rescue of the bankers; lack of trust in the advice of a split economics profession; and Nietzschean ressenUment of a sort. – I have no idea which is true. – But it is a fact that the standard Washington response is: “We kept unemployment from reaching 15%! Hooray for us!”
That Economists Agreed Governments Should Stabilize NGDP • What I thought three years ago: – Whatever theories economists worked on, they all agreed that the most important thing to stabilize was NGDP. – A sharp fall in NGDP would call forth a consensus among economists that the government should do whatever was necessary to get NGDP back to its previous growth path.
• Once again, not true: – The economics profession is badly split. – And here I have a big problem: the arguments of those who think that we should simply accept the fall in NGDP as part of what Schumpeter would have called “a healthy cold douche” seem to me to be so far from contact with reality that I can get no purchase on them.
So What Are the Lessons? • A modest proposal: should “macroeconomics’ as such be banned? • Macroeconomics should be taught only through economic history and the history of economic thought: – Start in 1800 with all issues of what the business cycle was or might become open. – Trace the developing debates: Say vs. Malthus, Say vs. Mill, Bagehot, Wicksell vs. Fisher, Hayek vs. Keynes. – Should we stop at Tobin?