What It Takes to Beat the Financial Crisis

Here is a bit from an interview with George Akerlof, a co-author with Robert Shiller of the book Animal Spirits from the Freakonomics website:

Freakonomics: We have to ask: as a Nobel Prize-winning economist, what do you think should be done about the financial crisis?

Ackerloff: We should have two targets: a target for aggregate demand and a target for credit. These targets force policy makers to have their eye on the ball. In the first target, there should be sufficiently large stimulus to aggregate demand that the economy would have at full employment. There should also be a credit target so that those who are doing legitimate business (not selling or buying snake oil) would be able to obtain loans under reasonable terms (on the terms they would normally obtain if the economy were at full employment and credit markets were operating normally).

For most important journeys, one of the most important decisions is the destination. By establishing and aiming for such targets (they are destinations for economic policy) the government will be able to plan sensibly. Roosevelt and Hoover had many programs. They were both very inventive about what to do in the Great Depression. But because they lacked firm targets, they were never sufficiently confident. The Depression could have been cured easily with an appropriately large dose of fiscal stimulus, but it was not applied. Unemployment in the United States only fell below 10 percent in 1941, which was some time after the start of the war in Europe, in September 1939. World War II, unfortunate as it was, then provided the fiscal stimulus that got us out of the Depression.

My chief criticism of Obama centres on his approach to the financial crisis. He is doing what the Japanese did post-1989. He is trying to "rescue" the banks when he should simply let them fail and help capitalize new banks under tighter regulation with enough capital to support the credit needs of the US. My other criticism is that his stimulus package is too small. Akerlof says "provide enough stimulus to keep the economy at its productive capacity". Obama isn't doing that.