REALITYBASE

I was born before WWII, and now is the first time it has ever occurred to me that we are in a recession from which we might not recover for a generation or more. I won't go into the reasons for my pessimism here, although I have written about some of them in previous posts. I write now only to report this recent insight and to point out that whether one assumes recovery or stasis should lead to profoundly different economic policy choices.

If we can have a recovery and resume economic growth and generalized prosperity in the near future, then it behooves us to use government fiscal policy aggressively and continue to keep money cheap to stimulate a recovery as rapidly as possible. The deficit accumulated to do that will be a much better thing to leave to the next generations than several unnecessary years—or a decade, or a generation—of stagnation, high unemployment, missed opportunities for education and career-building, declining international influence, etc., etc.

On the other hand, if this is the new normal, and we can't jump start the economy to perform like it did in the late 1990s, say, and we can't avoid a long period of high unemployment, stagnant family incomes, and declining prices—in other words, a lost decade or generation—then it would be better to start making now the painful adjustments that would be required to survive long-term in that environment. In this scenario, any stimulus money would add to the deficit but would have no expansionary effect. There would be not only smaller federal, state, and local government budgets, but smaller household budgets too. Infrastructure could not be expanded, properly maintained or replaced. Investment abroad might be more profitable than here. Funding for education would continue to decline, increasing the opportunity gap between rich and poor. The safety net for society's least vulnerable would be underfunded. Social Security benefits might have to be reduced, but there would be no employer-sponsored or private replacement—people would just have less to live on when they retire, if they can afford to retire at all. Net job creation would slow and could become negative. The average age of the population would increase as immigration of younger workers slowed and perhaps reversed, exacerbating the Social Security funding problem. The professional, managerial, and small business owner class could not avoid being sucked into this downward spiral, because the vast majority of their revenues come exclusively from what the others in their class and the 5/6 of American workers who are not bosses have available to spend. Real estate and other asset values would decline, and imported goods would become more expensive.

On this cusp of history, what we assume about the future may change what actually happens, which makes a wrong choice all the more perilous. If it is possible to pull out of the Great Recession only with aggressive stimulation, then doing too little or adopting policies appropriate for long-term stagnation might well foreclose the sunny path and assure the dark one. The Obama Administration seems to have chosen not to chose—it will not propose aggressive stimulation to help end the Great Recession, and it will not propose the painful policies that would be appropriate for long-term stagnation. We wait.

Update on Saturday, February 6, 2010 at 12:36PM by Skeptic

To the point that the professional class may also be getting sucked into a downward spiral, the president of the State Bar of California says it's unclear whether the current downturn in the legal profession is cyclical or structural.  He points to reports that legal work is being sent to India, that Beijing now has an English-language law school run the former dean of Cornell Law School and president of University of Michigan, and that some legal work is now being done in the UK by non-lawyers.  Meanwhile, clients are in rebellion at the billable hour model in which fifth year lawyers are billed at $500 per hour. 

Update on Thursday, February 11, 2010 at 04:45PM by Skeptic

Here is a post on some of the gruesome longterm effects on young people of trying to enter the workforce in a period of high persistent unemployment.

Update on Monday, March 1, 2010 at 02:09PM by Skeptic

Paul Krugman reminds us that when output of goods and services (GDP) is below its potential, those goods and services are not just delayed.  They are never produced--opportunity gone forever.  That's the argument for government stimulus to get the economy up to its potential as quickly as possible.  Otherwise, we are suffering, and bequeathing to later generations, a decline in wealth creation much larger than the public debt we avoid incurring if we don't make the effort.  PK illustrates with this graph from Mark Thoma (who got it from the Federal Reserve Bank of San Francisco):

Of course, PK's argument assumes we can raise output to its potential, which is the fundamental question I raised in the initial post, and that government stimulus programs work. I've been persuaded that well designed stimulus programs do work, but I'm not so sure our potential real GDP is still a rising curve.  Perhaps there are structural problems with our economy, such as globalization, that would not be fixed by economic stimulus and which are dragging us into a decade or more of unavoidable stagnation or decline.