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The Failure of the Self-Correcting Economy in Times Past

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Monday, 09 September 2013 10:21

Paul Krugman corrected my earlier comment to note that he in fact did say that the 1990-91 and 2001 recessions were qualitatively different than prior ones in that the recoveries did not have the same sort of strong bounce back that followed prior recessions. These recessions were also attributable at least in part to the collapse of asset bubbles. In this sense, the 2007-2009 downturn is not unique.

This is certainly fair, but at the risk of picking nits, there is another important point. Given the weakness of the current recovery, we all agree (I'm implicating Mike Konczal here as well) that stimulatory fiscal policy was and is appropriate to boost the economy out of the current downturn. However, are we in agreement that fiscal stimulus would have been useful following the 2001 downturn and perhaps the 1990-1991 recession also?

That seems to me the bigger issue. Maybe we are all in agreement and think that a fiscal response would have been appropriate for these prior two recessions as well, but I am not sure on this point.

("Knit" corrected, thanks folks.)

Comments (12)Add Comment
picking nits
written by Ed , September 09, 2013 11:10
I hate to be a nit picker, but picking knits is only done while shopping for sweaters.
nits not knits?
written by David, September 09, 2013 11:39
Seriously, though, it's a good question: do these types of recessions require a fiscal response rather than (just) a monetary response? I think so. The answer will be found in a flow of funds, though the current version offered by the Fed is outdated, since finance has changed greatly since the 1950s. If the bankers need credit swaps and all in order to keep the money system working, fine, but then it should be on the books, not hidden like it is now. Perhaps the unemployment problem is yet another aspect of Gresham's principle ("bad money runs out the good") where labor is now an undervalued currency. If that view does make sense from the view of flow of funds, then it explains why the finance sector is huge but the labor market is depressed.
Neoclassical Economics
written by Jeffrey Stewart, September 09, 2013 11:53
Dr. Baker is probably well aware that the only school of thought that believes variations in relative prices return the economy to full employment output levels is neoclassical economics. This is because their whole theory is built in the fantasy land of perfect competition where there's always instantaneous adjustment of relative prices effecting full employment output levels. That is, the conclusion that the capitalist economy (or whatever it is that neoclassicals analyze in their models) is always at full employment output levels is a corollary of neoclassical supply and demand curve price theory. In the face of exactly the opposite in capitalist reality, neoclassicals resort to ingeniously creative explanations where some imperfection in capitalist reality, e.g. sticky prices, including wages and interest rates (the ZERO LOWER BOUND!!!) or imperfect information, unfulfilled expectations(!) or even time prevent capitalism from working as the theory says it should. In short, their version of the problem is that capitalism doesn't behave the way neoclassical theory says it should.

It's worth nothing that there's no relative price variation, self correcting mechanism in neo-Ricardian or Marxian economics precisely because they have different price theories. These theorists actually have to analyze capitalism's real relations and provide deeper explanations for its normal, profitable operation and why it breaks down.
The Great Moderation of Self Correction After the Fact
written by Last Mover, September 09, 2013 12:14

Krugman quotes R&R:

Since the mid 1980s, however, we’ve had the “Great Moderation,” with inflation quiescent. Post-moderation recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.

And while they haven’t been as deep as the older type of recession, they’ve proved hard to end (not officially, but in terms of employment), precisely because housing — which is the main thing that responds to monetary policy — has to rise above normal levels rather than recover from an interest-imposed slump.


This suggests that post moderation era, housing can no longer lead an economy out of recession via monetary policy unless it overshoots the moderation era baseline, yet housing can lead an economy into a severe U shaped deep jobless recession while encouraged by monetary policy until it goes bust.

Not that monetary policy was the root cause of the bubble. It was not. But this does raise the question of dependence on asset bubbles to drive the economy, then depending on Keynesian stimulus to rescue the economy after bubbles burst, because monetary policy can no longer stimulate recovery through lower interest rates.

As long as asset bubbles are driving substantial demand, self correction can't happen, especially if recovery itself is a stimulus that ends up encouraging the next asset bubble.

The corollary question is, what would business cycles look like absent asset bubbles? If recessions still happened and monetary policy was still weak in stimulating recovery, does that imply fiscal stimulus should be applied routinely the same way monetary stimulus was applied in the past? If that works, does that mean self correction (through monetary policy only) is dead forever?
time and again....
written by pete, September 09, 2013 12:20
As Krugman points out regarding southern Europe, and with his desire for a 4% inflation rate in the u.s., it is indeed a neo-classical/Keynesian/behavioral issue. During a boom, wages rise. During the crash, corporate profits tank, as they did this time, prior to rebounding. Wages are stuck, a Keynesian/behavioral issue. Fiscal or monetary policy can take advantage of the behavioral problem, getting workers to inadvertently agree to work for lower real wages. I think they all agree on that. In that sense Stew is correct. Keynes was definitely not a Marxist. Inflation is a bad thing for workers, and fiscal policy is too. Since 1968 (peak income equality), the beginning of the war on poverty, large increase in government regulation, and in 1973 the unleashing of the fed, workers have suffered horribly. The corporatists have preyed upon this loose talk of fiscal stimulus. Unions used to be anti-Keynesians..they could figure it out before.
the fed unleashed
written by David, September 09, 2013 12:59
but pete, ever since the fed was unleashed and inflation beat down, the employment ratio went up, rather significantly. It's not as simple as you say.
employment up wages stagnant , Low-rated comment [Show]
need fiscal stimulus via deficits
written by M McOsker, September 09, 2013 2:40
Workers suffer because the economy need more net financial assets not tied to private debt. The only way that happens is via Federal deficit spending which equals net private savings.
George osbourne declares austerity a huge success
written by Jim, September 10, 2013 2:07
Fiscal Stimulus
written by jonny bakho, September 10, 2013 5:58
Absolutely there should have been more fiscal stimulus. There was a glut of tech in 2001 that could have been productively used if BigG would have purchased and made connections to the internet in rural areas and public schools and had a robust BigG Internet connection system, paid for by taxes. Instead they handed a cash cow to private business who collect rents and stifle commerce.

There were a lot of cuts by states and local governments, not as many as since 2008, but revenue sharing could have put people to work.

The automatic fiscal stabilizers worked. We need an infrastructure bank and an "automatic revenue sharing" for states that have fiscal shortfalls during downturns. Political response is often slow after the fact, but that does not mean that automatic stabilizers would not work, they do for unemployment benefits.
aid to states
written by Peter K., September 10, 2013 9:44
I believe Krugman admitted he was wrong to worry about deficits during the Bush years. At the time he did joke about Greenspan needing to create a housing bubble.

The leaked Summers memo about the Obama stimulus described elite opinion as believing that aid to the states provided the most bang for the buck in earlier recovery packages.
beyond the liquidity trap
written by paine, September 10, 2013 12:13
" a fiscal response would have been appropriate for these prior two recession as well,"

yes indeed line up on this one
for pk it would be a change
from
his FED " go solo " line
on effective demand stablization
pre 2008

for the USA
(if not Nippon
which hit the LT zero bound
in the 90's )

so is there fiscal macro above the zero bound and out of the Liquidity Trap

yes of course
we have known since the early 40's
fiscal injections work best for the broad job class
never "work your macro indirectly
thru the private for profit credit system
when uncle can borrow the needed funds for us and on our behalf

this has nothing to do with multipliers or bang for the buck
and everything to do with job class optimalities

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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