On Britain’s Austerity and Rosenberg’s Depiction of Obama as Herbert Hoover

I have written a post or two offering the opinion that Barack Obama faces an economy more akin to Herbert Hoover’s than Franklin Roosevelt. See "Barack Obama as Herbert Hoover" where posited the following:

My intent here is not to malign Obama, Roosevelt or Hoover or make facile comparison but to identify important differences between the economic situation facing Obama and the one that faced Roosevelt.

In my view, Obama faces a situation more akin to the one Herbert Hoover was forced to deal with because the economy is sill bottoming, unemployment is still rising and consumer spending is still falling. On the other hand, Roosevelt had the advantage of coming into office just as recession ended. This is an important difference in terms of political and economic constraints.

The reality is that this economic downturn and the financial crisis which created it is very large in magnitude and has deep structural roots in a leveraging of the household and financial sectors of the US economy. Moreover, the aftermath is global in scope as the on-going crisis in Europe, ratings downgrade in Japan, riots and government overthrow in Tunisia and civil unrest in Egypt demonstrate. I see these events as all inter-related due to the debt issues, the economic malaise and the economic policies used to counteract it.

The UK and the US are remarkably similar in their heavy dependence on financial services and the housing bubbles which preceded crisis. The similarity is greater when one looks at the initial political response in terms of deficit spending in both countries, double digit percentages of GDP. In the UK the budget deficit was a massive 11.4% of GDP in the last fiscal year. In the U.S., the federal deficit for the fiscal year ended September 2010 was $1.294 trillion or 8.9% of GDP, down from FY 2009’s 10%. Both countries have their own national currencies and central banks that have engaged in quantitative easing to support the economy. And both countries have very low interest rates despite massive deficits, unlike deficit spenders in the Eurozone without national currencies where national solvency is a gripping concern.

In many ways, this budget-busting spending makes sense due to the huge shortfall in private sector demand as the private sector contracted and tens of millions were thrown out of work. If government had countered this contraction in the private sector with one of its own, a Great Depression was sure to come. An appreciation of the financial sector balances makes this clear. That’s what I was talking about in October of 2009 with "Barack Obama: “if we keep on adding to the debt… that could actually lead to a double-dip”. "

But since that time, the US has resisted austerity while the UK has embraced it. In my mind, this is the best real-time economic experiment we can have on what does and doesn’t happen as a result of government spending. Personally, I think the budget deficits in the U.S. are unsustainable and I have written at length as to why. Nevertheless, I recognize that the large majority of the deficit in the U.S. has been driven by an output gap due to massive un- and under-employment.

My criticism of the Obama Administration has more to do with its lack of fight in creating jobs. And to the chagrin of my Keynesian readers, I am not talking about artificial boosts to aggregate demand. I don’t buy into the ‘aggregate demand is the only problem’ propaganda. The U.S. and the UK were on an unsustainable course with the FIRE sector (financial services, insurance, and real estate) sucking up an excessive amount of real resources that did not add to the longer-term capital formation. It certainly made a lot of people rich for a period of time. But for the societies as a whole, this misallocation of capital has been destructive, much more so than the telecom and technology misallocation which preceded the housing bubble.

The aggregate demand (AD) proponents act as if solving the AD problem makes everything ok. Are they saying that we want to return to the days of overinvestment in housing and financial services? Question: if we increased AD enough to close the output gap, would the unemployment rate in the housing sector be above the unemployment rate in other sectors? Question 2: is it not true that the housing and financial sectors saw an enormous fall in unemployment before other sectors, causing a ripple out into the rest of the economy from the largest areas of net addition to GDP as AD fell? Is it not probable that a collapse in the main driver of employment (FIRE sector) would ripple across the entire jobs market and induce a general fall in aggregate demand? Look at my credit crisis timeline and you can see that employment was plummeting in financial services well before the major uptick elsewhere.

Here are the Bloomberg headlines, all before Lehman collapsed, by the way:

  • 2008 01 24 Morgan Stanley, Lehman, Credit Suisse Cut 1,640 Jobs
  • 2008 02 26 Banks Cut More Than 28,000 Jobs as Subprime Losses Mount: Table
  • 2008 03 24 Wall Street Firms Cut 34,000 Jobs, Most Since 2001 Dot-Com Bust
  • 2008 04 22 Banks Cut 48,000 Jobs as Subprime Losses Mount: Table
  • 2008 05 06 Banks, Brokers Cut 65,000 Jobs as Subprime Losses Mount: Table
  • 2008 05 27 Banks, Brokers Cut 83,000 Jobs as Subprime Losses Mount: Table
  • 2008 09 26 Banks’ Job Cuts Reach 121,000 as Credit Woes Spread: Table

Not all unemployment will happen at the same time as proponents of the AD story assume. When you have a financial crisis brought on by a misallocation of resources, it will begin with the financial services industry and overbuilt sectors like housing, spread to capital goods sectors like autos, and then spread to other sectors as aggregate demand falls.  What I am saying here is that arguments about unemployment that are grounded in aggregate demand and arguments grounded in structural unemployment are not mutually exclusive. Aggregate demand is clearly lower than in 2007 and it has been maintained by government. Once AD has been revived, the structural issues – with many people having made lives around sectors that are in relative decline like housing – will still be operative. It is just like the structural issues that have faced the manufacturing sector. Or the structural issues that faced the oil patch between the mid-1980s and the late 1990s. There is no either or. In fact, when I hear comments that it is all about aggregate demand, it draws a visceral negative and emotional response from me in the opposite direction – this from someone who just argued that stimulus was necessary and who has consistently said the 2009 stimulus package was too small. That should tell you something; these all or nothing arguments are divisive and produce no positive outcome.

See my post Japan: stimulus without reform leads to a policy cul de sac for why I think the structural issues are important. And given Japan’s sovereign debt downgrade, this is something the U.S. and the UK need to understand. One last point here on Japan, when I wrote about this period as a recovery within a depression, I said the following:

  1. Most countries are in a state of economic weakness. That means consumption demand is constrained globally. There is no chance that the U.S. can export its way out of recession without a collapse in the value of the U.S. dollar. That leaves the government as the sole way to pick up the slack.
  2. Since state and local governments are constrained by falling tax revenue (see WSJ article) and the inability to print money, only the Federal Government can run large deficits.
  3. Deficit spending on this scale is politically unacceptable and will come to an end as soon as the economy shows any signs of life (say 2 to 3% growth for one year). Therefore, at the first sign of economic strength, the Federal Government will raise taxes and/or cut spending. The result will be a deep recession with higher unemployment and lower stock prices.

The recession is over but the depression has just begun, Oct 2009

The point is that it is never going to be politically feasible to run deficits that are double-digit percentages of GDP while printing money to keep the economy afloat and stimulate aggregate demand for long. It wasn’t possible in Japan, which is why they always sought to rein in their deficits, precipitating another recession. It isn’t possible in the UK or the US either. One can make all sorts of intellectual arguments that this is what should be done until we hit full employment, but politically, I don’t see it. That’s why the structural issues have to be dealt with swiftly.

I credit Obama in the US for taking the better path and debit Cameron in Britain for forcing excessive cuts on the UK much too early. And I think the potential double dip in the UK is not about weather; the poor British economy is also about austerity. The different outcome in the US and the similar outcome in Ireland point in this direction.

So, what about the Hoover comparisons for Obama? I still think they are apt – the reason Obama must still resist immediate austerity with the states and municipalities already in a world of hurt (which doesn’t mean I think he needs to subsidize banks, housing or autos, by the way).

So, I think that’s where we are: in the technical recovery phase of a double dip recession that is a once in a generation period of balance sheet repair. If you want to use the Great Depression as a guide, we are closer to 1931 in terms of events and timing (see Thinking about Creditanstalt today). But the policy response has been much more aggressive this time around. Ultimately, I think that means a technical recovery has taken form, even if the underlying fundamentals are suspect.

My hope is for a multi-year recovery – which was my prior baseline before the chances of a double dip increased. A multi-year recovery really should be the baseline outcome in any technical recovery scenario. However, this does not rule out a double dip per Shiller’s definition. In my view, this journey is far from over – as the continued low savings rate in the US and the policy errors on both sides of the Atlantic demonstrate. The shift, like those two previous periods, will take at least a decade to complete.

What is a double dip recession?, May 2010

Roubini’s conclusions about the budget strike me as on the money. I am less enamoured with the discussion about bond market vigilantes, though (video below).

Here’s what David Rosenberg saw from quotes from Hoover and Obama he published in his Breakfast with Dave piece today:

HERBERT OBAMA?

A long-standing colleague and reader sent this off to me yesterday and it blew me away. Read on:

Obama’s State of the Union:

“Two years after the worst recession most of us have ever known, the stock market has come roaring back. Corporate profits are up. The economy is growing again.”

Herbert Hoover, May 1st 1930, US Chamber of Commerce Meeting:

“While the crash only took place six months ago, I am convinced we have now passed the worst and with continued unity of effort we shall rapidly recover.”

Obama’s State of the Union:

“Thanks to the tax cuts we passed, Americans’ paychecks are a little bigger today. Every business can write off the full cost of the new investments they make this year. These steps, taken by Democrats and Republicans, will grow the economy and add to the more than one million private sector jobs created last year.”

Herbert Hoover, October 22, 1932, campaign speech in Detroit:

“It can be demonstrated that the tide has turned and that the gigantic forces of depression are today in retreat. Our measures and policies have demonstrated their effectiveness. They have preserved the American people from certain chaos. They have preserved a final fortress of stability in the world.”

Obama’s State of the Union:

“But now that the worst of the recession is over…”

Herbert Hoover, June 1930, to a delegation requesting a public works project:

“Gentlemen, you have come sixty days too late. The depression is over.”

Obama’s State of the Union:

“The steps we’ve taken over the last two years may have broken the back of this recession…”

Herbert Hoover, State of the Union, December 6, 1932:

“The unprecedented emergency measures enacted and policies adopted  undoubtedly saved the country from economic disaster…”

Is Rosenberg right in seeing these parallels and if so what should President Obama do?  You already know what Rosenberg thinks the President should do.

27 Comments
  1. Anonymous says

    Edward, while I may agree with you that government spending is not the only solution, I am curious where is your best take on the large deficits being a long term problem? You did not link to it in the article. Thanks.

    1. Edward Harrison says

      I will see if I can find a cogent discussion about long-term deficits. A good historical example of high debt to GDP ratios is Britain post-World War II. The British example shows that 200% debt to GDP does not mean national insolvency. However, it likely means either depreciation of the currency, low real GDP growth, elevated inflation or underinvestment in government-supported infrastructure. In Britain, we saw all four. None of these factors favour strong capital formation or relative growth in real wages. Britain ended as the sick man of Europe because it took decades to inflate and underinvest away the national debt whilst the currency depreciated.

      If you can point to real world examples of different outcomes, I would be much appreciated.

      1. Anonymous says

        Edward, I’m not sure I find that argument convincing. It could just as well be argued that, like now, the British were too anxious to reduce the high deficits incurred by the war and that the recovery could have been significantly stronger had they maintained the high deficit ratios rather than allow them to fall. The recovery may have been stronger and the elements you list above may not have occurred.

        So was it really the high persistent deficits which caused these events or their efforts to contain them?

        This is not withstanding tjfxh’s comment with which I agree.

        1. Edward Harrison says

          I wasn’t talking about high persistent deficits but a high debt to GDP ratio.

        2. Edward Harrison says

          This gets at my view in a cogent way:

          http://www.ft.com/cms/s/0/56a10136-2a06-11e0-997c-00144feab49a.html

          I don’t find anything objectionable in this view. My quibbles: the ratings agencies should not be dismissed out of hand. The downgrade is a signpost.

          Tasker doesn’t address the issue of under investment that I believe is an issue as interest payments eat up the budget.

          If you want to see this from the other side ask what if questions like: why not run the debt to to 300% of GDP; what then?

          1. Spc says

            Apropos agencies.
            Where is the S&P mounted in the Japanese constitution ? I do believe that sovereign in Japan is people of Japan.
            I still can’t fathom that bunch of folks from New York holds sway over 120 mln nation.
            Isn’t it that agencies are unaccountable for their ratings ( journalistic advice, First Amendment – this is their defense in courts) , isn’t that their ratings where at the heart of meltdown – Bill Black somewhere mentioned procedure of AAAing paper in mere 20 minutes.
            Many examples cast enormous shadow over moral standards and quality of their work.
            I’m inclided to shoot them, remove them from equation.

  2. Anonymous says

    Edward, while I may agree with you that government spending is not the only solution, I am curious where is your best take on the large deficits being a long term problem? You did not link to it in the article. Thanks.

    1. Edward Harrison says

      I will see if I can find a cogent discussion about long-term deficits. A good historical example of high debt to GDP ratios is Britain post-World War II. The British example shows that 200% debt to GDP does not mean national insolvency. However, it likely means either depreciation of the currency, low real GDP growth, elevated inflation or underinvestment in government-supported infrastructure. In Britain, we saw all four. None of these factors favour strong capital formation or relative growth in real wages. Britain ended as the sick man of Europe because it took decades to inflate and underinvest away the national debt whilst the currency depreciated.

      If you can point to real world examples of different outcomes, I would be much appreciated.

      1. Anonymous says

        Edward, I’m not sure I find that argument convincing. It could just as well be argued that, like now, the British were too anxious to reduce the high deficits incurred by the war and that the recovery could have been significantly stronger had they maintained the high deficit ratios rather than allow them to fall. The recovery may have been stronger and the elements you list above may not have occurred.

        So was it really the high persistent deficits which caused these events or their efforts to contain them?

        This is not withstanding tjfxh’s comment with which I agree.

        1. Edward Harrison says

          I wasn’t talking about high persistent deficits but a high debt to GDP ratio.

        2. Edward Harrison says

          This gets at my view in a cogent way:

          http://www.ft.com/cms/s/0/56a10136-2a06-11e0-997c-00144feab49a.html

          I don’t find anything objectionable in this view. My quibbles: the ratings agencies should not be dismissed out of hand. The downgrade is a signpost.

          Tasker doesn’t address the issue of under investment that I believe is an issue as interest payments eat up the budget.

          If you want to see this from the other side ask what if questions like: why not run the debt to to 300% of GDP; what then?

          1. Spc says

            Apropos agencies.
            Where is the S&P mounted in the Japanese constitution ? I do believe that sovereign in Japan is people of Japan.
            I still can’t fathom that bunch of folks from New York holds sway over 120 mln nation.
            Isn’t it that agencies are unaccountable for their ratings ( journalistic advice, First Amendment – this is their defense in courts) , isn’t that their ratings where at the heart of meltdown – Bill Black somewhere mentioned procedure of AAAing paper in mere 20 minutes.
            Many examples cast enormous shadow over moral standards and quality of their work.
            I’m inclided to shoot them, remove them from equation.

  3. Anonymous says

    The problem arose from rent-seeking substituting for productive investing. The solution is taxing away economic rent in order to discourage rent-seeking and incentive productive investment. The rent that is taxed away should be returned to the economy in the form of public capital investment in education, health care, basic research, infrastructure, etc, that builds a platform for the private sector to launch itself. This takes the funds extracted parasitically from the economy that would otherwise be sequestered as savings, which is a stock, and returns them to the economy as a flow that enhances production and increases productivity. To paraphrase David Hume inOf Money (1752), its the flow of money that greases the wheels of commerce.

    Otherwise, this financial crisis will be handled the way all financial crises are handled, that is, by transfer of funds from households to the financial sector to make up for losses sustained by the financial sector, and the conditions will be set up for a repeat of this process down the road.

    1. Edward Harrison says

      This is Michael Hudson’s argument and I agree. The right course of action would have been to let the financial sector shrink as reckless firms failed. Let the housing sector shrink as well and allow government to step in to fill some of the aggregate demand, promoting infrastructure building and funding for higher value-added production.

      The result would be more fair, would reduce moral hazard and lead to full employment and sustainable growth much sooner. What we are seeing now is continued crony capitalism and it will end badly.

    2. Edward Harrison says

      This is Michael Hudson’s argument and I agree. The right course of action would have been to let the financial sector shrink as reckless firms failed. Let the housing sector shrink as well and allow government to step in to fill some of the aggregate demand, promoting infrastructure building and funding for higher value-added production.

      The result would be more fair, would reduce moral hazard and lead to full employment and sustainable growth much sooner. What we are seeing now is continued crony capitalism and it will end badly.

  4. Anonymous says

    The problem arose from rent-seeking substituting for productive investing. The solution is taxing away economic rent in order to discourage rent-seeking and incentive productive investment. The rent that is taxed away should be returned to the economy in the form of public capital investment in education, health care, basic research, infrastructure, etc, that builds a platform for the private sector to launch itself. This takes the funds extracted parasitically from the economy that would otherwise be sequestered as savings, which is a stock, and returns them to the economy as a flow that enhances production and increases productivity. To paraphrase David Hume inOf Money (1752), its the flow of money that greases the wheels of commerce.

    Otherwise, this financial crisis will be handled the way all financial crises are handled, that is, by transfer of funds from households to the financial sector to make up for losses sustained by the financial sector, and the conditions will be set up for a repeat of this process down the road.

    1. Edward Harrison says

      This is Michael Hudson’s argument and I agree. The right course of action would have been to let the financial sector shrink as reckless firms failed. Let the housing sector shrink as well and allow government to step in to fill some of the aggregate demand, promoting infrastructure building and funding for higher value-added production.

      The result would be more fair, would reduce moral hazard and lead to full employment and sustainable growth much sooner. What we are seeing now is continued crony capitalism and it will end badly.

  5. DavidLazarusUK says

    I have had misgivings about timing of any stimulus. If too early all it does is reinforce mal-investment decisions. Much of the stimulus was in the form of a house buyers credit. Which might have just condemned many to potential losses. Which could deter many from buying a home in future, further harming the construction industry.

    What should have happened both here in the UK and the US was significant tax reform. An increase in income taxes and a reduction of indirect taxes which could stimulate activity. This would be far more progressive and allow the government to pay for unemployment programs. Once the economy recovers these will fall naturally, reducing the deficit. The US in particular should have not worried about shovel ready programs but had a long term vision of where to take the country. Many have suggested renewable energy. This would have two benefits. With a longer outlook it would encourage private investment, as it would give them time to invest. Shovel ready projects could just be an expensive form of welfare if they do not stimulate the economy for long enough. Though if they have substantial end user benefits that might offset that disadvantage. A home insulation program would be just such a program.

    What is required is time for make investments prove themselves. Eventually those housing investments will be shown to be useless and so lead to write offs. It will allow the markets to discover what over capacity exists and to adjust. That is why the stimulus was too early.

    I think as long as the US does not succumb to austerity its prospects are better than the UK’s. I do agree that the depression has not been missed just delayed. Once the austerity hawks and bond vigilantes get their way expect the depression to resume.

    1. Edward Harrison says

      What you write makes sense. I just think waiting to counteract the fall was both near politically impossible and risky with regard to debt deflation. You have to act immediately. In fact, I had been arguing the Feds should have acted pre-Lehman. Northern Rock or Bear was the time to act.

      Had we put a Swedish style plan in place so that when a Lehman came along, maybe there would have been fewer bailouts. One can’t say.

      But at a minimum you have to add the deficit spending when the private sector demand is collapsing or you get debt deflation and dead weight loss from a much deeper and larger depression.

      1. DavidLazarusUK says

        I actually think that a fast asset deflation would have been better. It would clear out all the malinvestments, and act like a forest fire clearing the economy for fresh growth. The problem in acting quickly is that invariably the politicians get railroaded into an impossible position. A perfect example being AIG. It meant there was no longer any risk for the banks. It would have meant the losses would have wiped out many banks but it would have stopped the situation where all the risky practices still continue. Now the banks are too big to save and have only got bigger. Banks will not lend when the collateral is falling, or demand much higher premiums. These higher risk premiums are also a hidden tax on the economy. The banks should have undergone a swedish style restructuring and breakup as well.

        When the crisis started it was said to be just a liquidity problem. Though trillions of dollars later pumped in by many central banks and the problem has not gone away. Because economies have slumped and asset prices are still falling in the developed economies because wealth accumulation through asset bubbles was made too easy by government policy. Valuations got completely out of alignment from fundamentals because the tax regime made it possible. Capital gains were taxed at a lower rate than income so if possible people converted income into capital gains to pay less tax. This happened particularly in the hedge funds. Speculation meant that long term investment was discouraged. This needs to change.

        In the thirties, much of the asset deflation had occurred by the time the New Deal had started to stimulate the economy. This time it seems that the Japanese model is being followed. Where assets are being allowed time to deflate. That cannot be good for new activity. Everyone will just wonder when the decline will stop, and wait till then. If we continue I suspect that the US and UK will have a stagnant decade or two, where there is little growth and the majority are made poorer from inflation. That is happening now in the UK very rapidly.

        The fact that main street is still being starved of funds means that there will be no recovery until assets have bottomed out. When you drag that out then expect the depression to be dragged out. We still have another 20% fall in US house prices and I suspect another 40% in the UK to come. So until these have occurred I suspect that growth will be weak.

        I am still in favour of deficit spending. Though initially I would have ended the US unemployment benefits caps of 99 weeks. This would put money into the hands of those who are most likely to spend it. Then fully funded any deficits of the states and communities so that they do not have to make people redundant. Then a large sum into occupational training. This would solve the structural problems quickly as long as there are jobs available.

        1. Edward Harrison says

          I agree that a fast deflation would be better. But I also think a fast stimulus is necessary to counteract the debt deflation then. Obviously there will be waste but with huge levels of unemployment that seems to be of less consequence as Skidelsky argued well in the video I posted earlier. On the other hand, bailouts like AIG are exactly the opposite of what we are talking about.

          1. DavidLazarusUK says

            I do think that debt deflation is underway anyway. It is also impractical to have fast deflation yet leave debts untouched. All that does increase the debt burden. Debts need to have the same fast deflation as well.

            The level of debts in the developed world was far too high and had to come down. De-leveraging can only be achieved manageably in a growing economy. In a stagnant economy it is only a transfer from one person to the tax payer, which cannot go on for ever. Better to wipe out those debts and start again.

            One issue that wakes the situation worse is wage cuts. So even if debts and assets fall if wages fall as well the relative position does not change, which means assets have to fall further to make them manageable and the same for debts. Then you get into a negative cycle.

      2. Gepay says

        It is almost like any debt that is invested in a useful activity or needed or useful infrastructure is a good debt if there is money (hopefully generated to pay it back). This is not where, for the most part the stimulus money went. Now there was some sense that some money needed to be thrown into the economy to stop a debt deflation spiral that would have harmed otherwise sound businesses and caused even more harm. what is apparent is that as has been stated, FIRE has gotten out of hand. It doesn’t pay its fair share of taxes. It is more about skimming increasing amounts of money out of the real economy and main street than allocating the profit of the real economy to those most likely to use it for productive ends. I agree with Ed that the Swedish model should have been adjusted for the bigger American problem. Nothing has been fixed so we are verging on another commodities bubble bust that will bring the double dip – that and the Euro dithering about fixing their broken model. Then there are the stories out of China – who can trust their statistics? I don’t think they are smarter or less corrupt than we are. Singapore is authoritarian but not corrupt and it works. The Netherlands is lot looser and a little more corrupt but it seems to work, Its, like what we need are governments that are interested in the general welfare of the people and not operating in some fantasy land like the US increasingly is. Big government, little government, what we need is competent uncorrupt government. Big Debts Little debts what need is debts that are for useful ends. It sure feels to me like its not over yet by a long shot.

    2. Edward Harrison says

      One other thing, David. While I support government research in technology like the research which led to the Internet, I can’t advocate tax breaks or subsidies like the subsidies. That’s picking winners and losers. So on the tax side, your comments about closing loopholes and simplifying things makes sense.

      1. DavidLazarusUK says

        It does not have to pick winners and losers. It makes a special R&D rebate for companies who come up with the products. Companies will make the choice themselves how they do the research, be it in-house or via a grant to a university department. They could also have a prize similar to an X prize.

      2. DavidLazarusUK says

        It does not have to pick winners and losers. It makes a special R&D rebate for companies who come up with the products. Companies will make the choice themselves how they do the research, be it in-house or via a grant to a university department. They could also have a prize similar to an X prize.

      3. DavidLazarusUK says

        It does not have to pick winners and losers. It makes a special R&D rebate for companies who come up with the products. Companies will make the choice themselves how they do the research, be it in-house or via a grant to a university department. They could also have a prize similar to an X prize.

  6. Anonymous says

    I have had misgivings about timing of any stimulus. If too early all it does is reinforce mal-investment decisions. Much of the stimulus was in the form of a house buyers credit. Which might have just condemned many to potential losses. Which could deter many from buying a home in future, further harming the construction industry.

    What should have happened both here in the UK and the US was significant tax reform. An increase in income taxes and a reduction of indirect taxes which could stimulate activity. This would be far more progressive and allow the government to pay for unemployment programs. Once the economy recovers these will fall naturally, reducing the deficit. The US in particular should have not worried about shovel ready programs but had a long term vision of where to take the country. Many have suggested renewable energy. This would have two benefits. With a longer outlook it would encourage private investment, as it would give them time to invest. Shovel ready projects could just be an expensive form of welfare if they do not stimulate the economy for long enough. Though if they have substantial end user benefits that might offset that disadvantage. A home insulation program would be just such a program.

    What is required is time for make investments prove themselves. Eventually those housing investments will be shown to be useless and so lead to write offs. It will allow the markets to discover what over capacity exists and to adjust. That is why the stimulus was too early.

    I think as long as the US does not succumb to austerity its prospects are better than the UK’s. I do agree that the depression has not been missed just delayed. Once the austerity hawks and bond vigilantes get their way expect the depression to resume.

    1. Edward Harrison says

      What you write makes sense. I just think waiting to counteract the fall was both near politically impossible and risky with regard to debt deflation. You have to act immediately. In fact, I had been arguing the Feds should have acted pre-Lehman. Northern Rock or Bear was the time to act.

      Had we put a Swedish style plan in place so that when a Lehman came along, maybe there would have been fewer bailouts. One can’t say.

      But at a minimum you have to add the deficit spending when the private sector demand is collapsing or you get debt deflation and dead weight loss from a much deeper and larger depression.

      1. Anonymous says

        I actually think that a fast asset deflation would have been better. It would clear out all the malinvestments, and act like a forest fire clearing the economy for fresh growth. The problem in acting quickly is that invariably the politicians get railroaded into an impossible position. A perfect example being AIG. It meant there was no longer any risk for the banks. It would have meant the losses would have wiped out many banks but it would have stopped the situation where all the risky practices still continue. Now the banks are too big to save and have only got bigger. Banks will not lend when the collateral is falling, or demand much higher premiums. These higher risk premiums are also a hidden tax on the economy. The banks should have undergone a swedish style restructuring and breakup as well.

        When the crisis started it was said to be just a liquidity problem. Though trillions of dollars later pumped in by many central banks and the problem has not gone away. Because economies have slumped and asset prices are still falling in the developed economies because wealth accumulation through asset bubbles was made too easy by government policy. Valuations got completely out of alignment from fundamentals because the tax regime made it possible. Capital gains were taxed at a lower rate than income so if possible people converted income into capital gains to pay less tax. This happened particularly in the hedge funds. Speculation meant that long term investment was discouraged. This needs to change.

        In the thirties, much of the asset deflation had occurred by the time the New Deal had started to stimulate the economy. This time it seems that the Japanese model is being followed. Where assets are being allowed time to deflate. That cannot be good for new activity. Everyone will just wonder when the decline will stop, and wait till then. If we continue I suspect that the US and UK will have a stagnant decade or two, where there is little growth and the majority are made poorer from inflation. That is happening now in the UK very rapidly.

        The fact that main street is still being starved of funds means that there will be no recovery until assets have bottomed out. When you drag that out then expect the depression to be dragged out. We still have another 20% fall in US house prices and I suspect another 40% in the UK to come. So until these have occurred I suspect that growth will be weak.

        I am still in favour of deficit spending. Though initially I would have ended the US unemployment benefits caps of 99 weeks. This would put money into the hands of those who are most likely to spend it. Then fully funded any deficits of the states and communities so that they do not have to make people redundant. Then a large sum into occupational training. This would solve the structural problems quickly as long as there are jobs available.

        1. Edward Harrison says

          I agree that a fast deflation would be better. But I also think a fast stimulus is necessary to counteract the debt deflation then. Obviously there will be waste but with huge levels of unemployment that seems to be of less consequence as Skidelsky argued well in the video I posted earlier. On the other hand, bailouts like AIG are exactly the opposite of what we are talking about.

          1. Anonymous says

            I do think that debt deflation is underway anyway. It is also impractical to have fast deflation yet leave debts untouched. All that does increase the debt burden. Debts need to have the same fast deflation as well.

            The level of debts in the developed world was far too high and had to come down. De-leveraging can only be achieved manageably in a growing economy. In a stagnant economy it is only a transfer from one person to the tax payer, which cannot go on for ever. Better to wipe out those debts and start again.

            One issue that wakes the situation worse is wage cuts. So even if debts and assets fall if wages fall as well the relative position does not change, which means assets have to fall further to make them manageable and the same for debts. Then you get into a negative cycle.

      2. Gepay says

        It is almost like any debt that is invested in a useful activity or needed or useful infrastructure is a good debt if there is money (hopefully generated to pay it back). This is not where, for the most part the stimulus money went. Now there was some sense that some money needed to be thrown into the economy to stop a debt deflation spiral that would have harmed otherwise sound businesses and caused even more harm. what is apparent is that as has been stated, FIRE has gotten out of hand. It doesn’t pay its fair share of taxes. It is more about skimming increasing amounts of money out of the real economy and main street than allocating the profit of the real economy to those most likely to use it for productive ends. I agree with Ed that the Swedish model should have been adjusted for the bigger American problem. Nothing has been fixed so we are verging on another commodities bubble bust that will bring the double dip – that and the Euro dithering about fixing their broken model. Then there are the stories out of China – who can trust their statistics? I don’t think they are smarter or less corrupt than we are. Singapore is authoritarian but not corrupt and it works. The Netherlands is lot looser and a little more corrupt but it seems to work, Its, like what we need are governments that are interested in the general welfare of the people and not operating in some fantasy land like the US increasingly is. Big government, little government, what we need is competent uncorrupt government. Big Debts Little debts what need is debts that are for useful ends. It sure feels to me like its not over yet by a long shot.

    2. Edward Harrison says

      One other thing, David. While I support government research in technology like the research which led to the Internet, I can’t advocate tax breaks or subsidies like the subsidies. That’s picking winners and losers. So on the tax side, your comments about closing loopholes and simplifying things makes sense.

      1. Anonymous says

        It does not have to pick winners and losers. It makes a special R&D rebate for companies who come up with the products. Companies will make the choice themselves how they do the research, be it in-house or via a grant to a university department. They could also have a prize similar to an X prize.

  7. Rob says

    I do not understand how Japans downgrade sends any message to the US or the UK? Who cares what the cartel of corrupt rating agencies has to say?

    You know the US always has the capacity to pay it’s obligations in full.

    Further, how can you fix the structural problems when by accouting definition through the sectoral balance equation you contradict your argumet? To fix the structural problems in the US FIRE the private domestic sector has to save while assuming an external deficit you claim will not budge, by definition you are implying the government has to run massive deficits. Otherwise, you are advocating slashing and burning the economy. I think I’d rather have some “wasteful” government spending than a depression to liquidate the malinvestments. What are the “true” malinvestments anyhow? Most of the bad mortgages are underwater because of high unemployment…how do you know when you have liquidated enough?

    Ed, I love your blog, but I do not understand clearly how you can merge your Austrian leanings with your MMT knowledge. If there are malinvesments reallocate the composition of AD at full employment. Not when 20% of our people are underemployed and unemployed. This reallocation of AD is achieved through the political process assuming the government is promoting the general welfare of it’s people. What is politically feasible today is a reflection of the politicians and a public that do not understand the operational reality. We got to take that ignorance head on!

    Thanks for a great blog and always posting thought provoking posts.

    1. Edward Harrison says

      There is no contradiction here, Rob. It is very possible to run a government deficit and add stimulus while still allowing the banking sector to shrink. I am very consistent in what I am saying. You should re-read to clarify.

    2. Edward Harrison says

      Also reallocation of AD is not just achieved through the political process but through the market. When the crisis struck, the failure of the banks was a sign that the sector needed to shrink. When the Deleveraging occurred that was a sign that the household debt levels needed to shrink. When house prices declined and housing starts dropped, that was a sign that the sector needed less capital.

      All of these market based signals were telling policy makers to let capital reallocate naturally. While this was ongoing the government should have invested in infrastructure and promoted investment in higher value added capital investment or environmental technology, all of which has been done. I argued above that we needed more stmulus not less, Rob. This way, the fall in demand was not to great but the reallocation could proceed.

      What we have now is the same structure we had before, with government propping up house prices, propping up the financial sector, propping up the auto sector. All of these sectors suffer from over capacity. Meanwhile people from those sectors are still unemployed. No jobs programs were done. So that means the stimulus seems not just too small but wasted as the people are still jobless and the capital is still being misallocated.

      And the ratings agencies may have low credibility. Nevertheless their downgrade is a signal that should not be overlooked. In 10 years’ time, this will be plain.

  8. Rob says

    I do not understand how Japans downgrade sends any message to the US or the UK? Who cares what the cartel of corrupt rating agencies has to say?

    You know the US always has the capacity to pay it’s obligations in full.

    Further, how can you fix the structural problems when by accouting definition through the sectoral balance equation you contradict your argumet? To fix the structural problems in the US FIRE the private domestic sector has to save while assuming an external deficit you claim will not budge, by definition you are implying the government has to run massive deficits. Otherwise, you are advocating slashing and burning the economy. I think I’d rather have some “wasteful” government spending than a depression to liquidate the malinvestments. What are the “true” malinvestments anyhow? Most of the bad mortgages are underwater because of high unemployment…how do you know when you have liquidated enough?

    Ed, I love your blog, but I do not understand clearly how you can merge your Austrian leanings with your MMT knowledge. If there are malinvesments reallocate the composition of AD at full employment. Not when 20% of our people are underemployed and unemployed. This reallocation of AD is achieved through the political process assuming the government is promoting the general welfare of it’s people. What is politically feasible today is a reflection of the politicians and a public that do not understand the operational reality. We got to take that ignorance head on!

    Thanks for a great blog and always posting thought provoking posts.

    1. Edward Harrison says

      There is no contradiction here, Rob. It is very possible to run a government deficit and add stimulus while still allowing the banking sector to shrink. I am very consistent in what I am saying. You should re-read to clarify.

    2. Edward Harrison says

      Also reallocation of AD is not just achieved through the political process but through the market. When the crisis struck, the failure of the banks was a sign that the sector needed to shrink. When the Deleveraging occurred that was a sign that the household debt levels needed to shrink. When house prices declined and housing starts dropped, that was a sign that the sector needed less capital.

      All of these market based signals were telling policy makers to let capital reallocate naturally. While this was ongoing the government should have invested in infrastructure and promoted investment in higher value added capital investment or environmental technology, all of which has been done. I argued above that we needed more stmulus not less, Rob. This way, the fall in demand was not to great but the reallocation could proceed.

      What we have now is the same structure we had before, with government propping up house prices, propping up the financial sector, propping up the auto sector. All of these sectors suffer from over capacity. Meanwhile people from those sectors are still unemployed. No jobs programs were done. So that means the stimulus seems not just too small but wasted as the people are still jobless and the capital is still being misallocated.

      And the ratings agencies may have low credibility. Nevertheless their downgrade is a signal that should not be overlooked. In 10 years’ time, this will be plain.

  9. Sandablo says

    “I credit Obama in the US for taking the better path and debit Cameron in Britain for forcing excessive cuts on the UK much too early”

    But Ed……the £ is not the $. A falling £ has a much greater proportional effect on UK inflation than the equivalent fall of the $ on the US.

    I think I’ve read in more than 1 place that the UK’s structural budget deficit is the highest in the advanced world? If Cameron did not do what he’s doing, the £ would crash at a greater rate than it’s done already, inflation would rocket even more than it’s doing now, interest rates would then have to rise and that would really put the kibosh on any chimeric economic recovery resulting from what you (and dare I bracket you with the Labour party?) seem to advocate. Better to suffer now and at this point in the electoral cycle, than to suffer a shed-more later.

    1. Edward Harrison says

      Time will tell is all I can say. I still think the contrasts will be illuminating in hindsight.

      And the pound seems to be holding up. I am not sure UK inflation is due to that factor. Something to investigate?

      1. Stevie b. says

        Yes, agreed, the £ is indeed holding up, but after a fall – and it’s holding up in meaningful part because of the actions Cameron has taken. The current inflation is also in meaningful part due to the £’s previous decline, which at least now seems to be helping exports.

        And yes, whoops, posted first with part of my email adds in error!

        1. Stevie b. says

          and it’s still doing it!
          Steve

  10. Edward Harrison says

    No one has offered an opinion on Rosenberg’s quotes. I didn’t find them great matches. Die Antwort of you?

  11. Sandablo says

    “I credit Obama in the US for taking the better path and debit Cameron in Britain for forcing excessive cuts on the UK much too early”

    But Ed……the £ is not the $. A falling £ has a much greater proportional effect on UK inflation than the equivalent fall of the $ on the US.

    I think I’ve read in more than 1 place that the UK’s structural budget deficit is the highest in the advanced world? If Cameron did not do what he’s doing, the £ would crash at a greater rate than it’s done already, inflation would rocket even more than it’s doing now, interest rates would then have to rise and that would really put the kibosh on any chimeric economic recovery resulting from what you (and dare I bracket you with the Labour party?) seem to advocate. Better to suffer now and at this point in the electoral cycle, than to suffer a shed-more later.

    1. Edward Harrison says

      Time will tell is all I can say. I still think the contrasts will be illuminating in hindsight.

      And the pound seems to be holding up. I am not sure UK inflation is due to that factor. Something to investigate?

      1. Stevie b. says

        Yes, agreed, the £ is indeed holding up, but after a fall – and it’s holding up in meaningful part because of the actions Cameron has taken. The current inflation is also in meaningful part due to the £’s previous decline, which at least now seems to be helping exports.

        And yes, whoops, posted first with part of my email adds in error!

        1. Stevie b. says

          and it’s still doing it!
          Steve

  12. Edward Harrison says

    No one has offered an opinion on Rosenberg’s quotes. I didn’t find them great matches. Did any of you?

  13. Anonymous says

    Re: Herbert Hoover.

    Republican rhetoric hasn’t changed in the health care debate either. The introduction of Social Security in the 1930’s was fought with cries of “socialism” “massive government power grab” and “sapping the moral fiber of the nation by denying a man the God-given right to die horribly in the street.”

  14. Anonymous says

    Re: Herbert Hoover.

    Republican rhetoric hasn’t changed in the health care debate either. The introduction of Social Security in the 1930’s was fought with cries of “socialism” “massive government power grab” and “sapping the moral fiber of the nation by denying a man the God-given right to die horribly in the street.”

  15. fresnodan says

    “The aggregate demand (AD) proponents act as if solving the AD problem makes everything ok.”
    I got plenty of demand, I just don’t got no money. If only I were a bank holding company…

  16. fresno dan says

    “The aggregate demand (AD) proponents act as if solving the AD problem makes everything ok.”
    I got plenty of demand, I just don’t got no money. If only I were a bank holding company…

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