Playing it Safe

From the Free Exchange blog at the Economist magazine. This post documents the utter failure of Obama to provide an adequate stimulus to get the US out of the Great Recession -- now renamed as the Little Depression -- caused by the banking panic of 2008:

THE Obama administration economic team has almost entirely turned over since the beginning of the administration. Austan Goolsbee is still wandering the West Wing but will be gone by the fall. That leaves Tim Geithner, who says he's staying despite rumours to the contrary. It's striking to contrast the views being expressed by ex-administration members with those still in charge. Christina Romer—who brought the president a plan for a $1.2 trillion stimulus back in early 2009, when the full scope of the unfolding labour market disaster was only beginning to become clear—has been a consistent voice arguing for more demand-side stimulus and for a focus on medium- and long-term, rather than short-term, deficit reduction.

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That's what the old administration hands are saying. What's their former boss saying?

Government has to start living within its means, just like families do. We have to cut the spending we can’t afford so we can put the economy on sounder footing, and give our businesses the confidence they need to grow and create jobs.

That's a wow statement. It's profoundly uneconomic. Government doesn't face the same borrowing constraints as a household. It seems clear that the government can afford current levels of spending. It wasn't that long ago that government revenues were far higher than they currently are. And there is precious little evidence that the confidence-creating impact of deficit reduction, if there's one at all, will compensate for the contractionary impact of budget cuts. It seems quite clear that cutting government will be a net negative for the current economy.

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I've been trying to think of a situation in which a country like America—rich, with good institutions and able to borrow in its own currency—has dangerously overstimulated its economy. When has a country like America and in America's position opted to do too much fiscally or monetarily, such that it found itself in a dangerous and irreversibly inflationary situation? There aren't that many data points, but I don't believe there's been such a case. Mr Summers is right; the risk to doing too much was minimal, while the risk to doing too little was significant. There was a strong case for policymakers to say, look, we'll continue to act until we've solved the problem or markets demand that we stop. Would there be the potential for waste and inefficiency in this approach? Absolutely. There is no question that more government involvement in the economy would have generated some misallocation of resources. At the same time, America has come nowhere close to making all of the positive return public investments available. And the real economic cost of the presdent sustained, long-term employment is frightfully high. Stimulus sceptics have not demonstrated, haven't come close really, that stimulus can't raise employment or that increased employment wouldn't be preferable to the status quo.

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On the monetary side, the story is the same. It seems clear that QE2 prevented a fall toward deflation last summer and provided at least some short-term boost to the economy. The message the Fed has been sending lately is that this—preventing deflation—is enough; that's all it can or should be expected to do. But this approach dodges the all-important question: if the Fed could have improved the economy's employment potential without meaningfully increasing medium-term inflation expecatations, shouldn't it have? And boy, it sure seems like it could, particularly now, when emerging market tightening is taking the steam out of commodity markets. Weighing upside risks with downside risks, how has the Fed arrived at the choice to prevent a Japanese-style deflationary episode...and then stop at that?

There's a lot that economists can't say with great certainty where stimulus is concerned. The profession will be wrestling with questions about macroeconomic stability policy for years to come. But I hope some academics will also focus their attention on the institutional shortcomings that contributed to such incautious timidity in America's government and elsewhere. All throughout this crisis, American officials played it safe, and in doing so they almost certainly made the economic situation more painful than it needed to be. Four years since the recession began and two years into recovery, they still haven't learned their lessons.

Obama went into office hoping to some kind of "Lincoln" figure who would bind up the nation by finding a middle way. He is going to go out of office as Hoover-2, the second president who failed to respond to the need of the people and let them huddle in Hoovervilles and wait in breadlines while he worried about "inflation" and "debt" and "the soundness of the dollar". Tragedy!