This matters to any discussion of Summers’ proposal. We ought to take time to reflect on the pro’s and con’s of fiscal and monetary policy with regard to each of the two economies. We also ought to opine on the pro’s and con’s of recession on each of the two economies. And, finally, we ought to reflect, as per alex, on the nature of asset bubbles as they affected/affect the two economies.

Let’s start with this: the ‘can’t make ends meet’ economy in which at least 150 million Americans already inhabit has been in serious recession for a long time. We’re only getting discussion about the ‘recession’ and, for example, the illusory government statistics (GDP, employment, inflation, poverty level) that have been used to mark the first economy to model because, well, you know why: folks are looking to some bad bonuses.

The housing/credit bubble sucked cash flow out of the distressed economy as well as the third group on the edge. Indeed, it drove many of the third group over the edge. The gains from sucking blood from a stone (what yves calls ‘zero to negative savings”; but we must also call: borrow and consume or perhaps, ‘livin large’) — these gains went to pump up the fees, salaries, benefits, and balance sheets of the first economy. As per the split in GDP gains between capital and labor, they certainly didn’t go to jobs or wages. Indeed, that was key to the strategy: instead of wages to support economic growth, we have seen borrowing — or put differently: Beggar thy neighbor (Only, of course, most of the first economy folks live in gated off ways so that they don’t have any sense of second/third economy folks being ‘neighbors’. Compare, for example, the immigration stands of first economy folks versus rest of nation.)

Further, because the first economy is knitted into the upside of the global economy — these gains also allowed the wizards of financial innovation and the very wealthy folks to whom they report to help sell out long term American economic security in exchange for fabulous personal gains.

In comparison, the tech bubble printed counterfeit stock to make lots of people rich in a similar fashion, but as alex points out, also to go on a wild R&D spree that, at least as a byproduct, led to new technologies that, in theory, could benefit others later.

This is just one comparison. Many more along all the various lines are needed to best understand what would be the ‘right’ thing to do. Not that Bush — or the economic elite who live in the first economy will ever do the right thing. But at least so that we can see what might make sense should we ever regain leadership with foresight and courage who care about more than themselves.

The recent credit bubble can be seen as particulary “bad” because loose credit enabled a massive allocation of capital to Non-productive assets, ie, houses. The debt to purchase these assets is by definition, non self liquidating. Combine that with the size of the asset class and its importance as the primary investment of the average american consumer, and we can see why this cycle of mis-allocation of capital may be particularly damaging to future growth.

We need to see some Schumpeterian “destruction” — of banks, of builders, of hedge funds, etc. — if only to promote the idea that greater regulation and/or transparency needs to be implemented in both Mortgage Lending and Structured Finance so that we aren’t able to convince ourselves of the same beliefs that fueled this mania for “investing” in non-productive assets.

We should only consider fiscal policy action if we feel that the threat of systemic risk has become so large that it dwarfs any consideration of prolonging the recession or incentivizing moral hazard.

I’m sick and tired of hearing about these proposed stick saves.

The biggest financial stimulus package that could be put together is a comprehensive set of regulations that force one or more I-banks to declare bankruptcy (Citigroup, I’m looking at you) and the rest to write everything off to get on with it.

Because this is impossible, we won’t see a recovery until at least mid-09.

Everything else is throwing good money after bad. You don’t fix the problems stemming from past easy money with more easy money.

Agreed completely on your first point.

On your second, I may be seeing things too much from an NYC perspective, but despite the noise, the 2001 recession was tame (if you lived outside Silicon Valley or were not otherwise getting a lot of dot-com related business. Management consultants, for instance, were hard hit). The 1980-1981 and 1991-1992 recessions were nasty, scary affairs. The 1991-1992 recession was so bad that Goldman partners were retiring early (that turned them into limited partners and froze the value of their holdings). It was a huge vote of no confidence. And in historical Wall Street downturns, the peak to trough fall in industry employment has been 20%. We didn’t see anything close to that in 2001.

So the cheap credit extended to keep the recession from going to what is arguably its needed level instead leads as you pointed out to asset inflation. And the sort of people who invested in dot com stocks were sufficiently different than the types that invested in real estate debt that very few people at the time connected the dots.

I’m also not sure I share much sympathy with the view that “a bit of recession may be a good thing now and then.” The last recession in ‘01 and the one that seems to have started last month had similar causes, in my view: speculative bubbles had caused an excessive amount of capital to be directed toward the bubbly sectors (telecom bandwidth the last time and housing/mortgages this time). The only credible reason to allow a recession (assuming the Fed & the Treasury had the power to avoid one) would be to make sure that the market got the message that too much capital had been allocated to the offending sectors. But surely the market both last time & this time seems to have gotten the message just fine. You didn’t see any venture-backed long-haul optical startups in 2001-2, and you are unlikely to see many major residential real estate projects initiated in ‘08-’09.

Just my two cents.