Throwing in the towel on policy makers

Earlier today, I had a brief e-mail exchange with Marshall Auerback in which I said that I had basically thrown in the towel on US (and global) policy makers. Early on in this crisis, I had advocated a number of policy paths which I think would have been infinitely superior to the ones actually chosen by the Bush and Obama Administrations, especiallyregarding limiting the socialization of losses. I am talking about massive fiscal stimulus, big bank pre-privatization, a move away from the asset-based economy and the accumulation of debt, and a reallocation of resources.

Quite frankly, none of these suggestions have been taken on. As I discussed in March when making a few comments on this blog’s harsher tone about the credit crisis, the prevailing view in policy circles seems to be that we are in full recovery mode now, the remedies we put in place having been highly effective. Therefore, we can put in a few minor tweaks to the financial system, use our propaganda machine to tout them as the largest regulatory changes since the Great Depression, and then return to business as usual.

I find this narrative very unsettling and the complacent view it represents as likely to lead to another systemic crisis in short order. But the mindset is fixed. This is the reality of our policy making elite.

And it seems that I am not the only one who has come to this conclusion.  Mark Thoma voiced similar views in a post earlier today.  In a post entitled "Giving Up on Policymakers", Professor Thoma said:

I’ve been pushing hard for more help for labor markets for quite awhile… but it’s probably time for me to give up and accept that we are going to have a slower recovery than we could have had with more aggressive fiscal policy…

The fiscal policy response to the crisis has been disappointing. Monetary policy loses its effectiveness in a recession. There are some things monetary policy can do…But when it comes to providing a big shock to aggregate demand sufficient to turn the economy around and propel it back toward full employment, monetary policy alone isn’t enough. It’s true that monetary policy can lower real interest rates — even at the zero bound for the federal funds rate, it’s still possible to use quantitative easing to nudge long-term interest rates downward — the problem is that all this does is create an incentive for more investment and consumption (mainly of durables), there is nothing to guarantee that people will actually respond…

Because monetary policy loses effectiveness in a deep recession — something I’ve been teaching for decades — I was among the first to call for aggressive fiscal policy. Fiscal policy creates demand directly, it does not rely upon incentives and the hope that people will respond to them. When the crisis hit, we needed fiscal policy right away. Given the lags between changes in policy and actual effects on the economy, which were known to be lengthy, and given that monetary policy was not going to be enough, there was no time to "wait and see" (as many people I respect were calling for). But the reality is that fiscal policy didn’t get put into place until much, much later, far too late to stop the worst of the downturn (and it wasn’t big enough anyway). The way too slow policy process, and the way too small policy that came out of it, was frustrating to watch.

I think we’d be much better off today if we’d done what is necessary right away instead of hoping and hoping that things weren’t going to be so bad, and that we could escape the need for an aggressive policy intervention. This crisis has taught me that policy of that magnitude is nearly impossible to put in place based upon what looks to be happening, i.e. before the recession actually occurs. There must be clear evidence that a severe recession is actually underway before policy will be considered. Unfortunately, by that time it’s too late to prevent the worst part of the downturn.

Now that we are hitting the other side, I’m feeling frustrated again with the lack of action from policymakers. I expect the recovery to proceed at a snail’s pace, labor markets in particular. If employment rebounds quickly, great, but that’s not what I think is going to happen, and that’s not what the evidence suggests. If the recovery is going to be slow, then it’s not too late to provide more help. Instead of getting back to full employment by, say, 2013, we could get there sooner if we act now.

I agree with Professor Thoma. His comment near the end of his post was the one of greatest importance:

But, as I said at the beginning, even though it’s not too late for more help to make a difference, it’s not going to happen.

The question, then, is what is going to happen.  I have made my arguments on this in the past. For example.

I expect the following to occur:

  1. Public pressure to withdraw monetary and fiscal stimulus will work and stimulus will be reduced quicker than many anticipate – beginning sometime in early 2010. The Fed has already said it will stop buying mortgages in March and the Obama Administration is now focused on deficit reduction as evidenced by the paltry jobs bill just passed.
  2. The fiscally weak state and local governments will therefore receive little aid from the federal government. This will result in budget cuts, tax increases, and layoffs by the end of Q2 2010.
  3. At the same time, the inventory cycle’s impact on GDP growth will attenuate. By the second half of 2010, inventories will not add considerably to GDP.
  4. Meanwhile, the reduction of Fed support for the mortgage market will reveal weaknesses there. Mortgage rates may increase, decreasing housing demand.
  5. Employment will be weak in this environment, leading to another spate of defaults and foreclosures.
  6. The foreclosures and weak housing demand will pressure house prices and weaken lender balance sheets, especially because of second-lien exposure. This will in turn reduce credit growth.

I expect the weakness in GDP from this scenario to be evident sometime in the second half of 2010.

The mindset will not change; a depressionary relapse may be coming, Mar 2010

But what about other more bullish views out there? Why can’t the economy be robust enough to withstand these problems? Aren’t banks earning enough to reduce capital constraints to lending? Isn’t consumption growth resuming? Why are munis the next shoe to drop? Couldn’t it be that the rise in asset prices will buoy their revenue streams?  These are all questions I ask myself (probably not publicly since "Is economic boom around the corner?" in Sep 2009). But I fail to see how in a world of the Greek sovereign debt crisis, the disputed Chinese asset bubble and a potential Sino-American trade war that these preconditions do not necessarily lead to economic weakness for the foreseeable future.

So rather than repeat these points ad nauseam, I am asking you the readers to debate this for me.  What am I missing?

  1. Anonymous says


    First, let me take this opportunity to thank you for this blog. I learn a lot from this blog. I really like your calm and collected approach to your writing.

    I am pessimistic as to how things will unfold going forward, my reasons being, I am seeing lot more layoffs in March, than I noticed and heard among friends and colleagues, in Feb and Jan.

    Second, lot will still depend on how, Housing Mkt will evolve going forward. I still see lot of Homes for Sales, where I am living. Some of the signs have been around for more than a year now. My feeling is next round of house prices decline is still ahead.

    Then how much of this so called positive feeling is because of mkt rally, which as you know plays a disproportionate role in our day to day life and feeling.

    Also, as Karl Denniger has pointed out many times, US spends around 10% of GDP through deficit financing. How long can this continue, not for much long and this has been going on for a longtime. In short, when we look into mirror Greece is staring back at us. So with Deficit spending by US govt., how will things end up looking.

    At every-given opportunity the Fed reminds Wall st., boys and girls, Fed will stand pat for “extended period”, it has essentially become a code word for partying.

    I could go on and on……….may be I am pessimestic………I still see S&P bottoming at around 150 to 300, before a genuine bull mkt is started.

    As old cliche goes, time will tell.

    Best to you and your family


  2. J A says

    90% of wallstreet is bullish because they get paid to be bullish. To them it always pays to be bullish because liquidity saves them. And there is always a story depending on how stocks move. If it is moving higher you need to buy because things are better. If it is lower, you need to buy because it is cheap.

  3. gnk says

    I think we are fighting one of the largest global deleveraging and re-balancing of trade episodes in the history of civilization. Technological advances and feel good trade agreements altered the world more so in the past thirty years than in all of history past. Unfortunately, the elites have too much to lose in implementing a sensible program – after all, they designed this system for primarily their own benefit. We’ll eventually get to where we belong… but it will be extremely painful. That which cannot sustain *itself* ultimately ends because the exogenous influences that prop it up (in this case, the elites), fail because they are ultimately less powerful than that which they are trying to control.

    But I have disagree about the massive fiscal stimulus approach. We’re fighting a deleveraging battle here. Moving debt growth from private to public balance sheets to maintain or grow a proven faulty and unsustainable aggregate demand number merely masks the real problem – our economy was unsustainable *before* the crisis. The crisis is merely a natural correction, reaching for equilibrium between debts and incomes, whether they may be the debts and incomes of individuals, corporations, or sovereigns. None are immune from mathematical reality.

    And least we fall into the linear thinking trap. Our world is three dimensional. Other factors come out of left field to knock out whatever plans we carefully craft on the economic front. My other fears are geopolitical in nature, as well as resource depletion – peak oil. Too many moving parts to make a decent prediction. Too few positive developments that can counter balance the convergence of so many negative factors. We all know what happens to complex systems when such challenges arise all at once.

  4. LavrentiBeria says

    You’re not missing anything, Ed. The regime and its flunkies will declare the recovery realized, the strategies brilliant and continue on. The similarity of these developments to that of David Betrayus’s Iraq “surge” is unmistakable. The blood letting between Islamist sects there was already on the wane by the time the surged trops reached Iraq. All that Betrayus managed to add to the equation was a cash distribution program that set about buying-off Sunni insurgents and turned our soldiers into bursars. Where it suceeded it was a financial not a military victory. Yet it was cast as a success! But has it been? Ask the victims of yesterday’s bombing, and the unstable political situation that has emerged from the recent Iraqi election. The formation of a government is now in the hands of an individual sworn to the expulsion of United States troops from the country. What you’ve described is simply the economic equivalent of the “surge” and we’re likely to have our own version of those Iraqi explosions.

  5. Scott says

    I think that Marshall’s recent statement conceding that a corrupt congress is its own worst enemy actually makes sense. In a perfect world I would not be a fan of your blog and I’d be skiing every day and Marshall would only be stimulating himself (remove this post if you please, as that was not meant to be personal, but I still couldn’t resist). However, they forced TARP down our throats when at the same time, they could have forced down the biggest fiscal spending program of all time in the same vein, but they didn’t and only told us we had to do it because they said so. I agree with neither tactic, but if Keynsians are correct and all we need is a superpowered jump start in aggregate demand, how can we believe experts that said all we needed was a huge slush fund to save us all telling us now that all we need is some huge government spending? Maybe despair will get us to that point, but even then, does the theory really justify huge gambles like we’re making? Let’s take the leap and face the writing on the wall and put some honesty back into our economy. That’s a scary proposition, but so is trying to spend our way out of this.

  6. Anonymous says

    i think that your analysis is correct but what you and all of us are missing is this outrageous cohabitation between politics and wall street, none has been indicted, GM bankrupcy was not carried out by the law, accounting changes are the norm allowing banks and companies to raise funds with false financial statements, the new regulatory framework to pass is a facade. This is the greatest theft of history to taxpayers, savers and workers to keep an order outdated, many thing come to my mind, this is gatopardism. Justice is a joke, really I expected limits, people sent to trial and but I am too naive.

  7. Jack says

    Even if you got the stimulus you wanted, it would be more waste than useful. It’s plain to see that politicians’ interests, Republican and Democrat, don’t align with society’s. They are as self interested as anyone else, using their positions to enrich themselves and their buddies.

  8. Reniam Troop says

    I disagree that we needed more fiscal policy stimulus. What are you trying to stimulate back to – debt fueled hyper-consumerism? We still need to get real in this country and ask a ourselves some harder questions.

    Debt is the problem not the solution. We need to de-lever and let the economy recalibrate itself. The government pounding money into whole sectors that should contract is not healthy.

  9. Edward Harrison says

    Here,s what I wrote as a comment on Naked Capitalism’s version of this post:

    Thanks for all the comments. Very helpful. Here are a few of my own.

    Right now, the Obama Administration is running a victory lap. They are still cautious enough to couch their verbiage in terms which recognize the ongoing struggle of many. However, it’s pretty clear from the last employment report that they are saying, “we did it.”

    As many of you already know, my throwing in the towel is more of a ‘rhetorical’ throwing in the towel, meaning I had given up on this lot long ago (think of my posts like the Fake Recovery from this time last year). But, I think it is important to document now what was said and what was done so that when events actually do turn out as I suspect they will, there will be little room for the propaganda and hackneyed “who coulda knowed” routine.

    I am pretty much of the liquidationist bent by nature (malinvestment and all that)(which for someone who commented on politics earlier means I probably couldn’t be labelled ‘liberal.’ I certainly wouldn’t like the label ‘conservative.’) As I see it, the aggregate private debt levels in the U.S., Britain, Australia are too high to be dealt with via stimulus/forbearance alone. So it’s somewhat incongruous with that to talk about massive amounts of stimulus as a ’solution’ to what ails us. The problem with a pure ‘liquidationist’ approach is what I voiced in December of 2008:

    “This would mean liquidating General Motors, bankrupting Royal Bank of Scotland and Citigroup or allowing Iceland, Hungary and Pakistan to fend for themselves. In theory, each of these measures seem prudent. But, in practice, these measures would result in huge job loses, would induce further deleveraging and asset price declines, would deplete capital from an already fragile global baking system, and would lead to a probable depression of unimaginable severity. It is in such a bleak environment that dangerous despots and dictators like Hitler and Mussolini rose to power, taking advantage of the natural human need for ’strong’ leader in a time of chaos and uncertainty. Could we expect any different today?”

    I think we can see the answer to this question even now based on the strife within the EU, between China and the US and the already significant problems elsewhere. In a worse economic climate, these problems would be an order of magnitude greater. The fact is a military solution to problems is always going to be inviting to some leaders when the entire world economy is in Depression.

    Obviously, there are not a lot of policy options out there. But, it’s not my role to say, “All of this stimulus is a waste of time because the politicians are too corrupt and will just waste. Moreover, the political process is so broken, only a Depression can galvanize an adequate political response to the crony capitalism controlling the system. Eventually we’re headed for collapse and only then will true reform come. Let’s just hope we don’t get World War 3 in the process.”

    Is that helpful? Would that change anything? No. Is it true? It is a plausible outcome and I certainly believe much of this. It might feel good to say stuff like this. But it is a pretty bleak point of view. However, I want to focus on more positive outcomes. I want to prevent worst case scenarios. So I write from that point of view. And I know for a fact that policy makers read what I and Yves and others in the blogosphere write and react to it.

    In the back of your mind, remember that we have already reached what I consider the limit of our present monetary, economic and political system’s ability to handle crisis. What we should be looking to do is to pull us back from the precipice and hope that, in so doing, we will(miraculously) understand the present calamity to be the extreme warning which it is that we are on the wrong path.

    I hope this makes some sense.

    To add further to this, specifically on stimulus, Marshall Auerback has said that tax cuts could also be effective as fiscal stimulus (although less effective than spending in his view). I would agree. The goal is not to bring back overconsumption and the asset-based economy. It is to help the private sector deleverage without having another systemic crisis. How does one do that by just pulling in one’s horns? The U.S. isn’t Latvia, you know. A 20% fall in US GDP means curtains for the global economy. And I assure you, the political and military environment in such a scenario would be dire indeed.

  10. Anonymous says

    What is missing is the ACTUAL dropping of the next shoe; without it, the psychology is ‘all is well’ and will continue to improve without additional solutions.
    Second shoe dropping will cause a panic to save more, spend less on both public and gov’t levels on a much more intense level… i.e. happens once and it MIGHT happen again, happens twice, and it might not stop happening. One shoe doesn’t flip from ‘greed’ to ‘fear’ hard enough to stay awhile. Two might put greed on the back burner for a lot longer.
    Wow, I’m getting too pessimistic. On a more constructive note, I believe that the public IS being forced to deleverage (no more credit) but the banksters are NOT being forced to do so. Ref. the FASB157 nearly free money etc., and no rules to STOP leveraging. (can’t deleverage if you’re still leveraging). Sooooo, the next CRUCIAL step is to FORCE the banksters to deleverage. Fight back hard against the millions of dollars Dimon and their ilk are spending to stop regulation.

    It sounds like what Ed Harrison and Prof. Thoma are trying to do

  11. barryschaeffer says


    I have to agree with you that we are probably seeing 1937 all over again.

    My only hope is that the Federal government will see what’s going on more quickly than they did in the 30’s and will adapt by ramming through some fiscal stimulus fast enough to prevent 20% unemployment. I’m telling my stepson to get into the Navy now. In fact, I’d argue that the biggest component of the remainder of the Middle Class is in the military.

    Thanks for this blog, Edward.


  12. Matt Stiles says

    This quote from Thoma:

    “Fiscal policy creates demand directly, it does not rely upon incentives and the hope that people will respond to them.”

    …is utter rubbish.

    Fiscal stimulus does not “create” anything. It either shifts demand from the future to the present or it wastes resources by shifting demand from things we need to things we don’t.

  13. ep3 says

    In regards to why their hasn’t been a bigger approach to job creation. come on man. this is just a continuation of ‘trickle-down economics’. Make money available to rich in hopes that their investing it will create wealth that will trickle down to the rest of us.
    they want to drive labor down because the unions had built such a rich and stable middle class over the last 50 years. they want to return to serfdom type system.

  14. ep3 says

    But I don’t think you are missing anything. I think we are not mentioning the ten ton gorilla in the room; the lack of wage growth, or the negative wage growth. ppl are broke, they can’t use their houses as ATMs anymore, and they have nothing else to bail them out. As Elizabeth Warren says, it costs more for ppl to live and they have less money to live on.

    I guess I have to ask, how do we raise wages? I, being a pretty socialist type person, actually don’t favor raising the minimum wage due to the immediate costs that it put on small businesses. Over the long term it helps them, but not short term. I think for one, if Obama would have introduced a single payer health care system, that would have freed up a lot of funds for people to spend.

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