Reflections on the Depression

Obama just fired off a few speeches on shared sacrifice. Meanwhile, Ben Bernanke is urging the government to spend more to recrank the economic engine. Apparently, Keynes’s popularity came about because he was the only one who offered activist ideas to stimulate the economy (aside from the tired supply-side idea of tax cuts). Not to be cynical or anything, but it seems that everyone turns Keynesian when we enter a recession and become supply-side when we are in boom years. Anyways, we can look at the example of Japan in the late 1980s, when it experienced an asset-inflated bubble, 80% tumble in the stock market, and heavy government spending to stimulate growth. The result has been a decade of stagnation and now the world’s highest debt as a percentage of GDP. What’s more, the Japanese people have essentially capitulated and given up on spending and are instead saving 50% of their wealth in low-yielding savings accounts (even at close to 0% interest).

Other academics have made similar calls for consumers to up their spending to counter the “paradox of thrift” that emerges when everyone saves at once in the face of a recession. For consumers, there is usually no choice; the average person is so indebted that there was no way spending could grow further. The massive credit overload that drove economic growth in the Bush years turned out to be illusory. The ensuing cycle of corporate losses, job cuts, and more consumer spending cutbacks makes for a deflationary cycle that is difficult to counter. Again, I reference Japan’s ongoing experience of collapsing consumer confidence, which is not an unlikely fate for more countries that don’t clean up their financial systems. However, on a personal level, I would recommend to everyone I know to save more in the face of the unknown. It’s a good idea to always spend less than one’s income while building up rainy day funds and long-term nest eggs. Personally, I save about 80% of my meager earnings each month – ab0ut $1600 from my TA job gets funneled into my savings account on payday, without debate. My checking account always has $500 in it at the beginning of each month, which is the hard limit for any spending in that month (typically $385 rent and $100 food). Since the recession hit, I have talked of cutting back even more, to the derision of Wayne, who says, “Any more belt-tightening and you’ll sever your GI tract.”

Granted, there have been moderate voices calling for alternatives to the current overreaction. Most notably, a package proposal by Jeffrey Miron relies on a rebalancing of spending, taxation, and immigration to get the country out of the malaise. However, those ideas are politically nonstarters because of their innocuous nature. The changes would be smart even during boom years, but in desperate straits, politicians want to be seen as active and energetic. What did Obama/Summers/Geithner say about this? Something like “it’s better to err on the side of action”? Perhaps not always. Greg Mankiw has a graph showing that in the long run, economic activity decreases due to crowding out. In other words, spending more might make the recession shallower, but it will make everyone worse off 10 years from now.

What is amazing about the current recession is the global nature of it. Economies everywhere are collapsing. Count Iceland, Brazil, the Eastern European Bloc, Russia, Dubai, Japan, and UK as the countries whose exposures are so deep that they will need bailouts from the IMF in the end (or at least see massive social upheval and unchecked populist rage). There will be widespread misery and maybe even some revolutions akin to after the First World War before it all passes. On a smaller scale, deteriorating job markets have are depressing wages for those who still have jobs while at the same time the unemployed cannot hope to find jobs that pay as much as they once did. If nothing else, the range of jobs hit – from executives to golddiggers – has been breathtaking.