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Which is the real catastrophe?

February 15th, 2009 · 1 Comment

The editorial pages of the Wall Street Journal (otherwise an excellent newspaper) are usually politically situated to the right of Attila the Hun. That’s ok with us (live and let live), but they urgently need an economics 101.

Here’s one example. A certain Bradly Shiller (an economist, I have to mention that because you wouldn’t have guessed) argues that all the talk by Obama about the terrible state of the economy is just scaremongering. Indeed, here is the title of his writing: Obama’s Rhetoric Is the Real ‘Catastrophe’.

Let’s begin to be kind. There is something in the argument that sounding alarm on the economy doesn’t make it better and could scare consumers and businesses to spend even less. But apart from that, the article goes badly of the boil. So badly that we wonder how the WSJ could have published it.

The main plank of the argument is that comparing the crisis now with the 1930s depression is unwarranted, and hence the stimulus policy is not needed.

Shiller comes up with some employment figures that show that unemployment was far worse in the 1930s. Indeed it was. However, is that a reason to do nothing? Hardly.

The simple truth is that unemployment reached such heights in the 1930s just because there were so many policy mistakes in the first couple of years.

We’re very early into the recession, compared to the 1930s, if we do nothing, who is to say what might happen. Irving Fisher, a contemporary of Keynes, has already shown how difficult it is to escape from a deflationary spiral, especially when debt levels are as high as they are now.

Do we really want to test that in practice?? It’s very simple. Once prices start to fall, the real debt burdens increases with the value of money.

We’ve seen something of that happening in the Asian crisis a decade ago, and in Russia today, when companies have a lot of debt in foreign currency, and their domestic currency falls, increasing the value of their debt. It becomes ever more difficult to pay back.

And that is childs play compared to what would happen if deflation would set in in the US, as it would affect all indebted households and companies, not just the fraction that has a debt in foreign currency. Spending will spiral downwards, reinforcing the deflation, increasing debt levels even more. This really is the stuff of economic nightmares.

With a spectre this dangerous, almost any measure is warranted. If anything, the stimulus package is way too modest, the output gap is closing in on $3 Trillion while the spending is just over a quarter of that, and a good part of that is wasted by rather inefficient tax cuts as well.

And (we can’t resist) where were all these guys who now worry so much about public deficits and debt levels, the last eight years..

Before you think we have something against conservatives, far from it. Here, for instance, is one article by a leading conservative (Nicholas D. Kristof, if you must know. Writing for the NYT doesn’t necessarily imply you’re a liberal..) we would wholeheartedly endorse:

Very sensible stuff. Investing in education has so many benefits, we can’t even begin to tell..

Tags: Credit Crisis · Public Policy

1 response so far ↓

  • 1 Darcy Patten // Feb 15, 2009 at 11:09 am

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