The Mistake of 2010

June 3, 2011

By
Published: June 2, 2011

 

Earlier this week, the Federal Reserve Bank of New York published a blog post about the “mistake of 1937,” the premature fiscal and monetary pullback that aborted an ongoing economic recovery and prolonged the Great Depression. As Gauti Eggertsson, the post’s author (with whom I have done research) points out, economic conditions today — with output growing, some prices rising, but unemployment still very high — bear a strong resemblance to those in 1936-37. So are modern policy makers going to make the same mistake?

Fred R. Conrad/The New York Times

Paul Krugman

Mr. Eggertsson says no, that economists now know better. But I disagree. In fact, in important ways we have already repeated the mistake of 1937. Call it the mistake of 2010: a “pivot” away from jobs to other concerns, whose wrongheadedness has been highlighted by recent economic data.

To be sure, things could be worse — and there’s a strong chance that they will, indeed, get worse.

Back when the original 2009 Obama stimulus was enacted, some of us warned that it was both too small and too short-lived. In particular, the effects of the stimulus would start fading out in 2010 — and given the fact that financial crises are usually followed by prolonged slumps, it was unlikely that the economy would have a vigorous self-sustaining recovery under way by then.

By the beginning of 2010, it was already obvious that these concerns had been justified. Yet somehow an overwhelming consensus emerged among policy makers and pundits that nothing more should be done to create jobs, that, on the contrary, there should be a turn toward fiscal austerity.

This consensus was fed by scare stories about an imminent loss of market confidence in U.S. debt. Every uptick in interest rates was interpreted as a sign that the “bond vigilantes” were on the attack, and this interpretation was often reported as a fact, not as a dubious hypothesis.

For example, in March 2010, The Wall Street Journal published an article titled “Debt Fears Send Rates Up,” reporting that long-term U.S. interest rates had risen and asserting — without offering any evidence — that this rise, to about 3.9 percent, reflected concerns about the budget deficit. In reality, it probably reflected several months of decent jobs numbers, which temporarily raised optimism about recovery.

But never mind. Somehow it became conventional wisdom that the deficit, not unemployment, was Public Enemy No. 1 — a conventional wisdom both reflected in and reinforced by a dramatic shift in news coverage away from unemployment and toward deficit concerns. Job creation effectively dropped off the agenda.

So, here we are, in the middle of 2011. How are things going?

Well, the bond vigilantes continue to exist only in the deficit hawks’ imagination. Long-term interest rates have fluctuated with optimism or pessimism about the economy; a recent spate of bad news has sent them down to about 3 percent, not far from historic lows.

And the news has, indeed, been bad. As the stimulus has faded out, so have hopes of strong economic recovery. Yes, there has been some job creation — but at a pace barely keeping up with population growth. The percentage of American adults with jobs, which plunged between 2007 and 2009, has barely budged since then. And the latest numbers suggest that even this modest, inadequate job growth is sputtering out.

So, as I said, we have already repeated a version of the mistake of 1937, withdrawing fiscal support much too early and perpetuating high unemployment.

Yet worse things may soon happen.

On the fiscal side, Republicans are demanding immediate spending cuts as the price of raising the debt limit and avoiding a U.S. default. If this blackmail succeeds, it will put a further drag on an already weak economy.

Meanwhile, a loud chorus is demanding that the Fed and its counterparts abroad raise interest rates to head off an alleged inflationary threat. As the New York Fed article points out, the rise in consumer price inflation over the past few months — which is already showing signs of tailing off — reflected temporary factors, and underlying inflation remains low. And smart economists like Mr. Eggerstsson understand this. But the European Central Bank is already raising rates, and the Fed is under pressure to do the same. Further attempts to help the economy expand seem out of the question.

So the mistake of 2010 may yet be followed by an even bigger mistake. Even if that doesn’t happen, however, the fact is that the policy response to the crisis was and remains vastly inadequate.

Those who refuse to learn from history are condemned to repeat it; we did, and we are. What we’re experiencing may not be a full replay of the Great Depression, but that’s little consolation for the millions of American families suffering from a slump that just goes on and on.

By

Robert Reich

Why aren’t Americans being told the truth about the economy? We’re heading in the direction of a double dip — but you’d never know it if you listened to the upbeat messages coming out of Wall Street and Washington.

Consumers are 70 percent of the American economy, and consumer confidence is plummeting. It’s weaker today on average than at the lowest point of the Great Recession.

The Reuters/University of Michigan survey shows a 10 point decline in March — the tenth largest drop on record. Part of that drop is attributable to rising fuel and food prices. A separate Conference Board’s index of consumer confidence, just released, shows consumer confidence at a five-month low — and a large part is due to expectations of fewer jobs and lower wages in the months ahead.

Pessimistic consumers buy less. And fewer sales spells economic trouble ahead.

What about the 192,000 jobs added in February? (We’ll know more Friday about how many jobs were added in March.) It’s peanuts compared to what’s needed. Remember, 125,000 new jobs are necessary just to keep up with a growing number of Americans eligible for employment. And the nation has lost so many jobs over the last three years that even at a rate of 200,000 a month we wouldn’t get back to 6 percent unemployment until 2016.

But isn’t the economy growing again — by an estimated 2.5 to 2.9 percent this year? Yes, but that’s even less than peanuts. The deeper the economic hole, the faster the growth needed to get back on track. By this point in the so-called recovery we’d expect growth of 4 to 6 percent.

Consider that back in 1934, when it was emerging from the deepest hole of the Great Depression, the economy grew 7.7 percent. The next year it grew over 8 percent. In 1936 it grew a whopping 14.1 percent.

Add two other ominous signs: Real hourly wages continue to fall, and housing prices continue to drop. Hourly wages are falling because with unemployment so high, most people have no bargaining power and will take whatever they can get. Housing is dropping because of the ever-larger number of homes people have walked away from because they can’t pay their mortgages. But because homes the biggest asset most Americans own, as home prices drop most Americans feel even poorer.

There’s no possibility government will make up for the coming shortfall in consumer spending. To the contrary, government is worsening the situation. State and local governments are slashing their budgets by roughly $110 billion this year. The federal stimulus is ending, and the federal government will end up cutting some $30 billion from this year’s budget.

In other words: Watch out. We may avoid a double dip but the economy is slowing ominously, and the booster rockets are disappearing.

So why aren’t we getting the truth about the economy? For one thing, Wall Street is buoyant — and most financial news you hear comes from the Street. Wall Street profits soared to $426.5 billion last quarter, according to the Commerce Department. (That gain more than offset a drop in the profits of non-financial domestic companies.) Anyone who believes the Dodd-Frank financial reform bill put a stop to the Street’s creativity hasn’t been watching.

To the extent non-financial companies are doing well, they’re making most of their money abroad. Since 1992, for example, G.E.’s offshore profits have risen $92 billion, from $15 billion (which is one reason it pays no U.S. taxes). In fact, the only group that’s optimistic about the future are CEOs of big American companies. The Business Roundtable’s economic outlook index, which surveys 142 CEOs, is now at its highest point since it began in 2002.

Washington, meanwhile, doesn’t want to sound the economic alarm. The White House and most Democrats want Americans to believe the economy is on an upswing.

Republicans, for their part, worry that if they tell it like it is Americans will want government to do more rather than less. They’d rather not talk about jobs and wages, and put the focus instead on deficit reduction (or spread the lie that by reducing the deficit we’ll get more jobs and higher wages).

I’m sorry to have to deliver the bad news, but it’s better you know.