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Parting Ways with the Pessimists

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Written by Dean Baker   
Monday, 06 February 2012 15:04

The economists who predicted the housing crisis tend to be a gloomy bunch, as Adam Davidson notes in his latest New York Times Magazine column. Dean Baker is the rare exception. In the following guest post on NPR's Planet Money blog, he explains why he has parted ways with the economic pessimists.

For more than five years before the recession began in December of 2007, I was one of the leading economic pessimists, warning of the housing bubble and the damage that its collapse would do to the economy. I based this pessimism on my analysis of the housing market, not a genetic disposition to pessimism. Given the economy's current situation, I find the warnings of the pessimists – the double-dip gang – to be wrongheaded and seriously counterproductive.

First to the economy's near-term prospects: the economy is growing and will in all probability continue to grow. Economies do generally grow. We see new investment, leading to more employment and higher productivity, which leads to higher profits and higher wages.

In the past when the economy has fallen into a recession it has been the result of plunges in house sales and car sales. Neither possibility seems plausible at the moment, primarily because both remain at extraordinarily low levels that leave little room for them to fall further. Even if they did fall, it would have only a limited impact since current demand is already so depressed.

It's difficult to see what else could cause another recession at this point. Cutbacks in government spending have been a drag on the economy the last two years. But state and local governments have largely adjusted to the plunge in tax revenues caused by the recession. There will be further cuts in many places, but they will likely be much smaller than the ones we have seen thus far.

Similarly, the federal budget deficit will fall through some mix of spending cuts and higher taxes. But this adjustment is unlikely to be so rapid as to raise any risk of recession, barring a very large political shake-up in the next election.

There is the possibility of a major event abroad causing a recession in the U.S. The two most-often mentioned candidates are a collapse of the euro or a collapse of the housing bubble in China and a meltdown of the Chinese economy.

While either of these events could cause huge disruptions to the U.S. financial system, both are highly unlikely. The European Central Bank and major European powers understand the risks of a disorderly default by Greece or another troubled European country. At the moment, they are playing games to extract as many concessions as possible, but there is little doubt that they would move aggressively if it appeared that things were unwinding.

Similarly, some of the people who are projecting a meltdown in China have been making such predictions for more than a decade. China's government has shown a remarkable ability to manage its economy through an enormous amount of economic turbulence.

In short, there seems little prospect that the U.S. economy will crater on its own. And the foreign events that could lead to a recession in the United States seem highly unlikely.

But it does matter hugely that the people putting forward the double-dip warnings are being taken seriously.

The problem is that if a double-dip recession is viewed as a serious possibility, even weak growth looks good by comparison. That is certainly what we saw in the second half of 2011, when the economy grew 1.8 percent in the third quarter, and 2.8 percent in the fourth quarter. Both reports were treated as good news since the economy was avoiding the dreaded double-dip recession.

In reality, this rate of growth is dismal for an economy that has been through a bad recession and is operating far below its potential. Following less severe downturns in 1974-75 and 1981-82, we saw several years in which the economy grew by more than 5 percent per year. The economy grew by 8 percent from the first quarter of 1983 to the first quarter of 1984.

In order for the economy to get back near its potential and to return to something resembling full employment in a reasonable period of time, we need much more than 2 to 3 percent growth. This sort of weak growth will needlessly condemn tens of millions of workers to unemployment or underemployment.

But if people think there's a high risk of a double-dip recession, then the public will end up being grateful for any growth whatsoever. And that would be the pessimists' fault.

Tags: economy | recession

Comments (1)Add Comment
IT Consultant
written by John Dougherty, February 15, 2012 11:20
Your argument seems strong ... right up to the point that you blame the pessimists for public acceptance of low growth. The pessimists have been mainly warning that austerity could send the economy back into recession.
You argue that government cutbacks "will likely be much smaller than the ones we have seen thus far." Not so if the stated plans of any the leading Republicans is actually put in place. That is not a negligible risk. I haven't seen an argument by any economist that coupled recession pessimism and complacency about slow growth. Quite the reverse. And in any case, "the public" does not follow economic debates nearly so closely as you imply. How the public feels about slow growth will be largely determined by their personal circumstances not by the views of the economic commenterati.

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