We Have Cleared the Bar‌ J. Bradford DeLong Professor of Economics, U.C. Berkeley Research Associate, NBER October 27, 2009
In America today--and in the rest of the world--the economic policy center is being squeezed. The Economic Policy Institute reports a commissioned poll showing that Americans overwhelmingly believe that the economic policies of the past year have greatly enriched the bankers of Midtown Manhattan and Canary Wharf (they really aren't concentrated along Wall Street or in the City of London anymore). In America the Republican congressional caucus is just saying no: no to short-term deficit spending to put people to work, no to support of the banking system, no to increased government oversight or ownership of financial entities. And the haute banque itself is back to business-as-usual: anxious to block any mandated reform of organizations or strategies or compensation packages, trusting to legislators eager to keep the campaign contributions flowing to delay and disrupt the legislative process if they can do so without leaving obvious fingerprints. I am not going to say that policy over the past two-and-a-half or ten years has been ideal. If I had been running things thirteen months ago, the U.S. Treasury and Federal Reserve would have let Lehman and AIG fail--but would have discounted their paper for cash at par provided that the paper also came with sufficient equity warrants. That would have preserved the functioning of the system while severely punishing the equity holders of the banking and shadow banking systems, and it would have left us today without anybody out there claiming that their risk management practices were adequate and did not need reform. If I had been running things
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nineteen months ago, I would have nationalized Fannie Mae and Freddie Mac and for the duration of the crisis shifted monetary and financial policy from targeting the Federal Funds rate to targeting the price of mortgages. Ever since 1825 the purpose of monetary policy in a crisis has been to support asset prices to keep the financial markets from sending to the real economy the price signal that it is time for mass unemployment, and nationalizing Fannie and Freddie and using them to peg the price of mortgages would have been the cleanest and easiest way to accomplish that. Nevertheless, policy over the past two-and-a-half years has been good: a fundamental shock bigger than 1929-30 and a financial system much more vulnerable to shocks than we had on the eve of the Great Depression, and yet unemployment is going to top out at 10% rather than 24% as it did in the U.S. during the Great Depression, nonfarm unemployment is going to top out at 10.5% rather than 30% as it did in the Great Depression, and we are not going to have a lost decade of economic stagnation as Japan did in the 1990s. Admittedly, the bar is low. But our policymakers have cleared it. It is worth stepping back and asking: What would the world economy look like today if policy had followed the "populist" demand of no support to the bankers? What would the world economy look like today if Congressional Republican demands for no TARP program and no additional stimulative deficit spending had been met? The only natural historical analogy is the Great Depression itself. That is the only time when (a) a financial crisis caused a widespread, lengthy, and prolonged reinforcing chain of bank failures and (b) the government neither intervened nor gave its baton to a consortium of private banks to support the system as a whole. Bear Stearns failed and was taken over by JP MorganChase with the assistance of up to $30 billion of Federal Reserve money on March 16, 2008: it is now nineteen months later. The Bank of United States--with 450,000 depositors--failed on December 11,
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1930, the first major bank failure in New York since the Knickerbocker Trust failure of 1907 during that panic and depression. Nineteen months after the failure of Bear Stearns it was July 1932: industrial production then, according to the Federal Reserve index, was 54% below its 1929 peak level. The mind rebels against the hypothesis that an absence of government intervention and support could have produced an economic decline of that magnitude. Modern economies are stable and stubborn things. Market systems are resilient webs which offer the best possible incentives to people to make deals and use resources productively. A 54% fall in industrial production between its 2007 peak and today, when industrial production stands 14% below its peak, is inconceivable--isn't it? There is only one argument against this conclusion that things would not have been *so* bad if the government had washed its hands of the economy--refused to conduct expansionary deficit spending fiscal policy, refused to recapitalize banks, refused to nationalize troubled institutions, refused to buy financial assets in non-standard ways. The argument is that all the theoretical reasons to think that depressions as deep as the Great Depression simply do not happen to market economies applied just as well to the 1930s as they do to today. And it did. It did happen.
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