A look back at the debate on the role of monetary and fiscal stimulus in depression

By Edward Harrison of Credit Writedowns. As Yves is in light posting mode, I wanted to run these thoughts by you here at Naked Capitalism regarding stimulus and the role of government in a debt-deflationary environment.

As we approach the new year, I have decided to write a few thematic posts as a look back at some of the more important economic topics that this credit crisis has uncovered. The thinking is that tying posts together in a theme might give a better holistic view of a few themes than the posts do in isolation.

The first topic is this: does fiscal or monetary stimulus work? That has been a consistent theme at Credit Writedowns.  And given my recent post backing away from fiscal stimulus as a policy tool, I thought it an opportune moment to explore the subject a bit via a full scale review of previous posts at Credit Writedowns.

Broadly speaking, the policy choices in a deep downturn are the ones I outlined last month in “Stop the madness now!.”

You have four options:

  1. No stimulus. Let the chips fall where they may. Yves Smith calls this the ‘Mellonite liquidationist mode.’ The thinking here is that trying to avoid the inevitable bust only makes it that much larger. And the economic policies during recessions in 1991 and 2001 seem to bear that out. The Harding Recession of 1921 is commonly seen as gold standard response.
  2. Monetary stimulus only. Quantitative easing mania. My understanding is this is what Ambrose Evans-Pritchard has been advocating.   The thinking here is that the flood of money and the low rates will eventually jump start the economy. No deficit spending needed.
  3. Monetary and fiscal stimulus.  Full tilt Keynesian. This is the Krugman view. The thinking here is that one needs to credibly commit to higher inflation and close the output gap to avoid a deflationary spiral. If that is insufficient, then one needs to go full bore on fiscal stimulus aka deficit spending. And if that doesn’t work, subsidize jobs. The New Deal is commonly seen as the gold standard response.
  4. Fiscal stimulus only. Deficit spending. I have been talking up this view. The thinking here is that we need to both close the output gap to prevent a deflationary spiral and revive private sector savings in order to promote deleveraging.

There is no magic bullet here.  We are living through a situation unique in time with few historical precedents. And there are a lot of competing ideas being tossed about. So policy makers are groping around, desperately seeking the holy grail of depression-busting economic policy.  In that regard, I don’t envy them. They are certainly going to make a lot of mistakes. It may seem at times that I don’t realize this given the harshness of my critiques, but I do.

When I started writing about the financial crisis, I took the first view, best exemplified in my pre-Lehman posts on the origins of the credit crisis and precedents in Japan and the Great Depression. My thinking at the time was that if policy makers recognized the full extent of the crisis and stayed ahead of the curve, we could get through this with a short but very sharp downturn.

However, policy makers were woefully behind the curve.  A recent article in the Washington Post highlights how Ben Bernanke and the Federal Reserve were blindsided by the crisis. So, when the panic that resulted from the Lehman crisis struck, I felt that the jig was up. We had been catapulted overnight into a seriously debt-deflationary economic environment in which monetary policy was ineffective. Option number two was out as a policy tool. Quantitative easing was not going to work.

The following posts outlining our thinking on these topics.

As I saw it, the Lehman failure marked a clear change in possible policy paths. As I outlined yesterday:

when Lehman Brothers collapsed in a heap, it was clear to me that we faced a stark choice.  One choice was a deflationary spiral and the associated economic dead weight loss of a non-equilibrating global economy in Depression.  The other choice was a soft depression cushioned by fiscal (and monetary stimulus). About a year ago I wrote an ode to Keynesian economics called Confessions of an Austrian economist in which I said that I choose fiscal stimulus to cushion the downturn and prevent a depressionary spiral.

And this is the line I stuck to. I think the real debate about whether or not to try fiscal stimulus revolves around the role of government and its limitations. Ideologues on one side see government as a parasite which interferes with the free market.  On the other side, ideologues see government as the only way out of a crisis of this magnitude.  The key sticking point is not just the size of government, but also its effectiveness – the political will to effect change rather than to favor constituents as recent research suggests bailout money was used.

I have tried to outline this debate with a few posts that point to both sides of the issue.

The majority of Americans fall in neither of the two ideological camps.  I would argue that the reason Barack Obama was elected was his message of hope and the promise of “change you can believe in". That had many of us – including me – thinking government can add stimulus while simultaneously encouraging saving and deleveraging, reducing dependence on asset prices, and allowing zombie companies to fail.  This is government dispensing with crony capitalism. The posts below are an ode to that reasoning. You can see Buffett, Kasriel, Gross and Galbraith all taking this line.

So, how has this worked out in practice? Not so well. From the very start, Obama’s lead by negotiating with oneself approach led to a weak and poorly crafted stimulus package.  My comments in “Obama takes middle road on stimulus and taxes that leads nowhere” from February sum up what was likely to happen (emphasis added):

In my view, it has become ever more apparent that the Obama administration is caught in some sort of muddle, trying to fudge between the calls for fiscal discipline from conservatives and the calls for stimulus from liberals.  Obviously, it is in Obama’s nature to lead by consensus, and he has looked for an inclusive political and economic strategy since he came to office.  However admirable these intentions may be, this middle path is unfortunate because it will leave no one satisfied.  Moreover, taking this middle path on the economic front — some stimulus but not massive stimulus, some tax cuts but also some increased spending, increased spending now but tax increases or budget cuts in a few years – is the worst of all outcomes; the economy will not gain enough traction to get the desired ‘jump-start’ and stimulus will ultimately be seen as ineffective.  If the Obama Administration later attempts to return to Congress for more of the same after a failed stimulus bill, it will find a more skeptical response

My view here is that Obama is forging a middle path that leads to a dead-end. The stimulus is not nearly enough by half to get the job done. The proposed deficit reduction measures for 2013 are outright scary as they risk repeating a mistake from the 1930s. And the banking sector and mortgage plans, both of which I failed to mention, are dubious half-measures as well. One needs to act aggressively and proactively or not at all.

This is exactly what has transpired.  To make matters worse, his team’s lack of accurate economic forecasting has led to an Armageddon scenario at the state and local level, where even unemployment benefits are not adequately funded. All of this was predictable as evidenced by these two posts from early in the year.

The President has effectively discredited fiscal stimulus as a policy tool. What’s more is the bailout of the too-big-to-fail institutions without strings, the apparent cronyism in how these bailouts were done, and the gutting of financial reforms by the financial lobby has also discredited government as an agent to level the playing field for struggling households and taxpayers. See Blodget: Obama suffers because “taxpayer always finishes last” for now, but I will take this subject up in another thematic post.

I certainly underestimated the degree to which cronyism and special interests ruled the roost in Washington. I no longer believe government can be an effective agent of change in the U.S any more than it has been in Japan (see “Japan: stimulus without reform leads to a policy cul de sac”).   As I wrote in “Stop the madness now!

If you are going to deficit spend you need to do it in a big way. You need to stop the deflationary spiral.  That means hitting the reset button by promoting private sector savings and deleveraging and purging all built-up malinvestments. The risk in addressing the situation this way, of course, is replacing the imperfect invisible hand of markets with the imperfect hand of politicians and legislative fiat.

This is a risk I no longer see as worth taking. I have bailout and deficit fatigue just like most Americans. It is abundantly clear that this Administration has absolutely zero intention of purging any malinvestment or promoting any deleveraging. All they want to do is continue business as usual and go back to the asset-based economy that caused this mess. This is why we have seen bailout after bailout coupled with easy money. It makes for record profits on Wall Street but it does nothing for the unemployed.

Moreover, the political process in the U.S. is such that any stimulus money will be diverted to pet projects and used to pay off political constituents. While this may increase aggregate demand, it does so at the risk of serious social unrest as the outrage will certainly spill over into populism.

So, I have developed a case of big government revulsion as I suspect many Americans have done. I will let Marshall Auerback argue the case for fiscal stimulus and its role leading to a sustainable recovery.  I am moving away from stimulus happy talk to focus on malinvestment.

Comments are appreciated.

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About Edward Harrison

I am a banking and finance specialist at the economic consultancy Global Macro Advisors. Previously, I worked at Deutsche Bank, Bain, the Corporate Executive Board and Yahoo. I have a BA in Economics from Dartmouth College and an MBA in Finance from Columbia University. As to ideology, I would call myself a libertarian realist - believer in the primacy of markets over a statist approach. However, I am no ideologue who believes that markets can solve all problems. Having lived in a lot of different places, I tend to take a global approach to economics and politics. I started my career as a diplomat in the foreign service and speak German, Dutch, Swedish, Spanish and French as well as English and can read a number of other European languages. I enjoy a good debate on these issues and I hope you enjoy my blogs. Please do sign up for the Email and RSS feeds on my blog pages. Cheers. Edward http://www.creditwritedowns.com


  1. tyaresun

    Good post. Helps me understand your thinking a little better (I feel your posts are more equivocal than not).

    The number one thing I am angry about is regulatory failure. The number two thing I am angry about is the monetary policy. Once we were in the crisis, I favored fiscal policy as the solution but even there I was not happy with the package we got (too many tax cuts).

    I don’t think we are out of the woods yet. I thought that the US was much more open minded and will be able to get out of the crisis much faster than Japan. I still believe that but not as strongly as I did a year ago.

    1. Fed Up

      I see a do nothing option.

      I see more attempts to create more private debt.

      I see a more gov’t debt option.

      I see a combination of the last two.

      Can you see another option? I can.

  2. Tao Jonesing

    Really excellent post, Ed.

    “I certainly underestimated the degree to which cronyism and special interests ruled the roost in Washington. I no longer believe government can be an effective agent of change in the U.S any more than it has been in Japan.”

    I find myself thinking exactly the same thing all the time. I used to believe that government had a positive role to play (and I still think it can), but I don’t think it does as it is currently constituted. It seems like the federal government is all about legislating private “taxes” that accrue to the benefit of one favored industry or another (e.g., Wall Street or health insurance). To that extent, it would seem that the federal government would view regulatory failure as a feature, not a bug.

  3. wally

    It seems to me that one obvious truth demonstrated in the past 2 years has been: money in the hands of bankers does not stimulate Main Street. It also seems obvious, though demonstrated in flush times rather than sparse, that money in the hands of Main Street is highly likely to stimulate banks.
    Those facts suggest that fiscal stimulus might be helpful, but that even a nickel spent on banks beyond what insures their bare survival is wasted.

  4. Ishmael

    Mr. Harrison:

    I am sorry, but if you did not see the cronyism and corruption in Washington before then you must still believe in Santa, the Easter Bunny and the Tooth Fairy.

    This economy has been fiscally stimulated for 20 years. That is how we have obtained such large deficits as well as unfunded liabilities.

    Why does everyone believe there must be some way out of this box with out pain? Do you believe in
    American Exceptionism. Do you not believe that mathamatics and physics apply to the United States.

    There was maybe one way to get out of this mess and get things going. Refund people back their tax returns for one to three years with some max and min. Then people could pay off their debts, save and invest. Those that can not get out of the hole with this deserve to fail and should be allowed to fail. Those that were prudent would be awarded. Sure it would have set off a round of inflation and devaluation but this would be brief and once again the prudent would survive without a scratch. Banks would survive. All of the cronyism would have been removed and that is why the elected officials would not do it.

    Right now we are on the verge of destoying the economy as well as the country.

    Maybe we need a few years of the Terror to put fear back in our elected officials. I walk around disqusted every day. The more I watch our elected officials the more disgusted I get.

    1. Edward Harrison Post author

      I told you from the outset that I thought cronyism was a problem, but one that was surmountable with evidence of a deep downturn at our door. It doesn’t seem surmountable to me at this point.

      Why the sarcasm?

      “you must still believe in Santa, the Easter Bunny and the Tooth Fairy.”

      As it stands, your comment doesn’t add a whole lot of value to the discussion.

      1. Gary Anderson

        Cronyism is the issue. There is a giant cronyism that protects the top 1 percent. There is deficit spending to help these guys out in commercial paper, there is plunge protection to help them out with stocks, there is monetary policy to help them out in their bad loans by weakening the dollar. There is cronyism to help out GS, JPM, C, etc.

        I would suggest that cronyism is centered with the central banks and the BIS. This is the ultimate cronyism. As long as insiders know when banks will have low capital requirements, or high capital requirements, and the direction of interest rates, these insiders can make a killing. They can make a killing in up times and down times.

      2. JasonRines

        I agree, no need for that insult toward you Mr. Harrison. You had high hopes like a lot of us that government would pile large sums of fiscal stimulus into long-term economic policy such as energy creation. We also hoped after it was painfully obvious, a serious banking reform package would be on the table. I was thinking in 2008 they would either nationalize the banks right away going the Swiss route or RTC2.
        I lost all hope in the Administration the moment I heard Healthcare was the President’s centerpiece of his Administration. Healthcare would have been the third priority if I was President B.O. Also, I would have broadly announced the day after I was President that all Americans enjoyed the boom, all share the pain and sacrifice of the bust.

        The actions I am seeing out of Washington resemble those of a Banana Republic, the Senate of Caligula or other highly negative references to widespread looting of Treasury before a government collapse.

        Thomas Jefferson did tell us the only good thing about Democracy (mob rule) was that it extinguished itself very quickly. Of course, Jefferson talked less about the anarchy and violence that occurs during the collapse of such a nation. Perhaps the kingmakers feel no backlash could occur if they were physically located in Asia, a dangerous assumption. The American people are very forgiving in general but once riled up, extreme vengeance is a hallmark trait of the society.

      3. i on the ball patriot

        The Santa sarcasm is valid and adds a lot to the discussion in that it suggests that you might want to make; “discredited government as an agent to level the playing field for struggling households and taxpayers.”, a promised later theme, your FIRST thematic post.

        As I have said many times here before, you can suggest remedial policy until the cows come but it will just be all fantasy without a government that is responsive to the will of the people.

        And it is not “big government revulsion” that I am feeling, it is corrupt government that is ‘non responsive to the will of the people’ revulsion that I am feeling, as I suspect many scamericans are.

        Sooooo … until you discuss the; who, what, when, where, and why of crooked government, and how best to make it democratically responsive to the will of the people, you are simply crafting letters to Santa Clause. Regaining control of the government will provide the thematic platform for what policy the people want. Also discussed under that thematic umbrella will be the aggregate generational corruption of government that has made most all scamericans such timid and pliable marks.

        Deception is the strongest political force on the planet.

        1. pebird

          Sarcasm is never valid – it’s “criticism for morons”.

          I’m as frustrated as anyone, while I understand the depth of corruption throughout business and government, I am surprised how little effort is made to even attempt to hide corrosive self-interest. Perhaps the crisis is more serious than we even appreciate. Or maybe our culture is too “ironic” (or sarcastic) to be shocked anymore.

          The one positive aspect to the crisis given the political context is the rapid depreciation of Obama’s image in the public’s eye. There are a few “progressives” remaining that are spending a lot on energy trying to justify their blind cheerleading – sooner rather than later they will realize they need to jump ship while they have some credibility remaining.

          Hopefully the public will realize that it doesn’t matter what the marketing, what image, what neo-socialist-realist posters are used, that the leadership in Washington won’t do a positive thing until the public decides to take citizenship seriously and begins to organize.

          1. i on the ball patriot

            “Sarcasm is never valid – it’s “criticism for morons”.”

            Interesting … Joseph Heller used sarcasm profusely in Catch 22 … and that is what this Santa sarcasm, for me, appeared to point out – the Catch 22 of putting the cart before the horse and putting forth remedies for a non responsive government. It was a few lashes to Ed for doing so.

            Yes, the public needs to take citizenship seriously and begin to organize. That is what should be on the front burner, that should be the first theme. In that process the public may decide to treat money and credit as a public utility and get rid of the parasitic bankers and all of their shit talking economists, in which case the four stimulus options offered may be rendered moot and the time discussing them wasted.

            Deception is the strongest political force on the planet.

  5. Cullpepper

    oOP… one comment.

    I would love to hear your take on the (1) likelihood and (2) impact of an external geopolitical event(s) on this particular apple cart.

    The israel/iran shadowboxing match springs to mind, but only because it is in the news this week. I can think of a good dozen external crisis triggers that might push the economy back into cascading failure mode.

    What do you think it would it take to get some “cushion” back?

  6. William Mitchell

    A great mystery of Keynesian fiscal stimulus is why return on investment is not considered an important decision factor. Keynes famously said you could just bury money in jars, and have miners dig them up, to maintain full employment.

    But if Keynes is right, then even a stimulus with a negative 110% return on investment, such as ground forces in Afghanistan, would be a good idea in his view.

    This just can’t be right. The capital allocation decision is central, whether made by business, individuals or government.

    Obviously domestic infrastructure investment yields more economic output than overseas military. Obviously education yields more than either of those. We throw around the idea of fiscal stimulus without considering that there is no rational, evidence-based decision-making structure in place to do so rationally.

    1. pebird

      It’s not much of a mystery. While Keynes did make that statement, it was somewhat tongue-in-cheek in response to some critics he was frustrated with.

      The point is that without aggregate demand, there can be no ROI for the private sector. In fact, there will be no “I” at all without demand – so don’t even worry about the “RO”.

      If government needs to make some less-than optimal investments (and there is no reason to think they must be so), the benefits from increased aggregate demand will offset these inefficiencies.

      However, it is one thing if the investment is inefficient (or dumb), but to Edward’s point, what if the investment is corrupt? That might be the most effective way to “prove” Keynes wrong.

  7. Brick

    There ought to be a 5 choice where by you can provide lots of stimulus without increasing the deficit and trashing your currency. This I think is what government would like, but lacks the ability to make the tough decisions to implement.
    You talk about malinvestment and perhaps we should consider that better focused investment would actually provide a significant stimulus. This might be achieved by channelling investment flows with tax incentives, but of course this would wreck the plans of many financial institutions.
    Let us also be honest about government spending, some of it is specifically there as a gravy train for government officials and would much better be spent on the economy.
    At the end of the day there is a limit to the ability deficit spend, I am not sure where it is for the US but suspect it might be lower than some suspect. Yes it could be monetized but that would most likely pose significant risks to world trade through currency valuation.
    It matters not because at the end of the day China will decide by leveraging its US treasury holdings to get the decisions it wants.

  8. Jerry

    I see it from a more worldview…Recent reports indicate drug money was used for the bailout…This makes sense when I remember how hard it was for the drug money to be laundered at local banks…they’re into the big ones now…oh and just this week alQueda(SP?) arrested for running drugs between N Africa and Afganistan..hum my thoughts are the bank drugsters are now in the Middle East…so the US sends troups to protect the drug interests and the oil so that the World finanical interests are maintained….I am no longer a fan of Obama..I just see as a puppet of the above….Only world wide bank-drugsters into oil could refuse to show respect for the office of the Pres of the US (not the man mind you)…and care not for the downfall of our and the world economy….Time to watch out for yourself, family, and neighbors…These guys are mor than dangerous…evil!!!

  9. Ishmael

    Mr. Harrison:

    I apologize for the sarcasm, but practially every fiscal and monetary economist I read seems to think they can stimulate our way out of this.

    The other day I saw something by Forbes saying that there is $800 trillion of debt and unfunded liabilities in the US. Ok, lets cut that in half saying the other half is hyperbole and call it $400 trillion. How much stimulas do we have to perform to start pushing this liability up the hill.

    OK, here is my experience. I have successful managed the turnaround of four public companies. Management teams prior to my arrival had always attempted to grow their way out of their problems and failed. I came in whacked costs, negotiated haircuts on debt (never filed 11) and grew revenue by empowering and rewarding people at the lowest levels. I see the same thing needs to be done in this country.

    As Reagan (and I am no big supporter) said, the government is the problem. Unfortunately, neither he nor any Republican since has solved this problem and in fact allowed the problem to grow much larger. This problem can not be solved by some large central planning committee. We need to empower and reward the people and let the losers (Oh, yes there are losers out there who want to feed off of the living) fail.

    One time I had a department that was failing. I wanted to fire the losers but my managers kept preventing me saying they could not hire anyone to replace them. Finally, after another terrible performance I came in and fired the 10 people who were the worse performers. This took all of 5 minutes (individual performance was tracked on a daily basis). The next day that department’s (which consisted of about 80 people) performance doubled and climbed until it became one of the best department in the company. As a guy who worked there (he had no hands or feet because his mother took Thalidomide) he wondered why he should work hard if we were going to keep the losers around and pay them as much as he was making.

    Economists around this country seem to think that this problem can be taken care of with no pain. It is kind of like some person who smokes two packs of cigarettes, drinks a bottle of whiskey and eat beef steak for fourty years goes to see the doctor and he has all of the expected illnesses and expects the doctor to cure him with a magic wand.

    Bush stimulated the economy and Greenspan gave it the monetary adrenaline shot. Once all of this wore off where was the country. Now, top economists want to do the same in larger quanities and more of it. Guess where that will take us.

    I saw this coming and have profited greatly. In June 0f 2008 I told some one I was so short I was like a walking black hole. I had been telling people it was coming since 2003 but people were telling me I had lost my mind. Well, not all some profited greatly.

  10. killben


    I have always sided with Option 1 because ..

    1. I always feel that is the best way to go in a true Capitalistic society
    2. It provides the needed checks and balance that is needed for a successful Capitalistic system
    3. I had felt without getting excess out of the way you cannot have a true recovery … For e.g. take the case of housing .. look at what is happening … all these people who are buying houses because of tax-credits .. what happens when people are underwater if prices falls further such that these people are underwater even afetr the tax-credits (highly probable)
    4. Best option as there is no moral hazard … in addition to the wiping out of banks, management etc. who have done badly it would have given the well run companies a piece of its competitors at a good price, and also the regulators who had been sleeping at the wheel should have been given the marching orders
    5. May be there is a crying need for a new financial system .. this would have given a new slate to start with ..

    Even now these guys are playing games like “extend & Pretend”, “hide & hype” .. not allowing at the very least an orderly failure to happen ..

    Now I am just waiting for another crisis where Fed will not be able to intervene as it is between a rock and hard place already …

    My feeling is still you can’t defy gravity …. so without some painful adjustments this porblem is unlikely to be solved and the longer you take the more time you lose on recovery … remember human beings are resilient and they will triumph over advertisity … probably as Bernard Shaw ( I think) said .. due to some unreasonable and successful people!!

  11. cyber seer

    You end with comments appreciated so here is mine:

    I am impressed with the evolution of your writing and understanding, in the beginning of your posts on this blog I generally thought you are overly optimistic and gullible when it comes to the government’s response and stability of the current system.

    I recently watched your interview with Max Keiser and I have to say you were right on point there as you are in this post. I congratulate you for proving to be a learner and not an ego driven writer out to defend his thesis to the death.

    I look forward to seeing where this path of learning will take you.

  12. jaznights

    I think the main point is still missing from all the options described. The reason we are in such a bind is not just fiscal policy, but the fact that we have gotten rid of all our manufacturing capability and therefore good paying working class and middle class jobs while allowing the wholesale transfer of wealth to the elite. We got by for a while by giving the average American cheap credit so they could go deep into debt to make up for the lost income but thats run its course. You can’t fix this depression with fiscal policy until you address industrial policy and start redistributing wealth more equitably. Anything else is just rearranging deckchairs on the Titantic.

  13. Jefferson

    I think what you are missing is the reality the Obama administration never really had any interest in jump starting economic growth. It probably never occurred to you that Obama actually set out to discredit the notion that stimulus could kick start economic growth.

    If the wimpy stimulus package did not convince you then the massive concerted global effort to significantly reduce carbon emissions should have made things abundantly clear. The agenda of the Obama administration and the global elite is about reducing economic growth not encouraging it.

    1. Weapons of Mass Deconstruction

      So, let me get this straight.

      The government can’t be trusted to be apolitical in its decision-making process with capital-allocation decisions (i.e, our taxes) already, and you want to further empower them with direct credit screening and loan underwriting?

      Great idea.

      I’m sure that won’t be used as a political tool whatsoever.

      Nor, will they patently disregard potential losses since they have what they perceive as a money tree, no doubt.

      I can’t wait to see how long it takes for people to willingly hand over every last thing to Big Brother.

      At this rate, not long.

  14. Jon Claerbout

    You said there are 4 options for stimulus. I offer a 5th.

    Instead of government offering cheap loans to banks, it should offer cheap loans to taxpayers. Add up taxes paid in the last 3 years and offer to loan it back on good terms.

    1. Weapons of Mass Deconstruction

      So, let me get this straight.

      The government can’t be trusted to be apolitical in its decision-making process with capital-allocation decisions (i.e, our taxes) already, and you want to further empower them with direct credit screening and loan underwriting?

      Great idea.

      I’m sure that won’t be used as a political tool whatsoever.

      Nor, will they patently disregard potential losses since they have what they perceive as a money tree, no doubt.

      I can’t wait to see how long it takes for people to willingly hand over every last thing to Big Brother.

      At this rate, not long.

  15. attempter

    This is similar to my disillusionment. I used to support stimulus in theory, but now I take it for granted that under this system it would only be diverted in reactionary crony ways like cash for clunkers.

    Same for a VAT: I used to support the idea in principle. By now I assume that in practice it would only be an added regressive assault which would not substitute for any other taxes but only be added to them. (What we need is a rationally and morally progressive tax structure, which we’ll never get under this political system.)

    Even something like the filibuster: Even a year ago I strongly advocated doing away with it.

    But by now, since I assume no major legislation coming from these “2” parties will be anything but a further feudal assault on the people, I figure that the best we can hope for is permanent gridlock (for as long as these conditions hold), and that means the filibuster can only help.

  16. Rahul Deodhar

    Thanks for a comprehensive round up. I think whether stimulus will work or not depends on initial condition.

    1) A good metaphor is like using steroids for quicker recovery in certain cases like Arthritis. A person is able to walk bearably using steroids – therefore they work. But then, can you recommend same steroids if his leg is fractured. This is problem of scale.

    In all our earlier recessions stimulus was a good solution as problems were smaller. Even in great depression, stimulus came in AFTER a lot of damage was complete. In our analogy it is like after the plaster cast was removed – but pain was still there.

    2) In any case, there are cases where you use monetary in other fiscal in some both and that is, to my mind dependant on situation. Monetary creates excess money at the top layer hoping effects will filter down through bank lending etc.

    Fiscal, I mean properly directed Keynesian dig a hole-fill a hole type job creating fiscal, creates small amount across the levels. This, to my mind, is better at creating or supporting demand in excess supply or flexi-suppy situation.

    3) In conditions such as now, or pre-Lehman post sub prime, we have scale problem, coupled with survival issues. If we don’t take stimulus we die! So stimulus was necessary. But given the national debt and looming liabilities, what was required was a fine control between fiscal and monetary stimulus. Plus the monetary transmission was broken and everyone knew it. In addition, there was enormous malafide intent which is yet to be dealt with. So within the stimuli there needed to be flexibility to let few companies and business practices fail or disappear. It was like a Nadia Comanechi’s perfect 10 in a John Rambo situation.

    My disappointment with Obama is that he took the academic approach and neglected on-ground realities. His campaign was ground up so it should have been easier for him to set up ground-level feedback mechanism to feed into his eco-strategy discussion. If anyone could do it he could – but there was not much of a chance. I hoped he would start with stronger permanent job creation + job loss prevention rather than easy money policy. Delaying auto bailout did not make much sense. Anyways the bailouts are mostly bunk – they will only create future liabilities.

    So I agree with you middle-road policy comments. But I think stimulus is an effective way provided initial conditions are favourable.

  17. Andrew Bissell

    And there are a lot of competing ideas being tossed about. So policy makers are groping around, desperately seeking the holy grail of depression-busting economic policy.

    I think the term “holy grail” here is apt. Why is it so few are willing to consider the possibility that macroeconomic holy grails are as imaginary as the Last Supper version? That there is no nice way to unwind a 25-year credit mania?

    At any rate, I appreciate your fair-minded posts on this debate Mr. Harrison.

  18. Jerry

    Hi Andrew….I won’t put down your belief system….please respect mine…the Last Supper is blessed to me…Thanks!

    1. Andrew Bissell

      Was not intended to cause offense. Whether or not one believes the Holy Grail existed at one time, I think we can agree searching for it is probably a waste of time and effort better spent elsewhere.

  19. Ishmael

    One last point which can address some of the additional comments.

    Economists seem to only look at what I would call the income statement side of things. Very little attention is paid to the balance sheet side. For instance we talk about GDP but there is no thought to the amount of borrowing that must take place to generate that GDP growth.

    If a balance sheet is debt free and a country/company is sluggish then a little prudent leverage can be added and get things going; however, after that the prudent thing is to pay the debt back. On the other hand, you can continue to add debt upon debt. Guess what happens at some point when the economy becomes stagnant again then more debt will go from being a positive thing to a negative thing. Due to the exceptional place the US held coming out of WW2 and the execptionalism being ingrained into people’s mental thinking around the world, the point of stimulus being negative occurred much later in the US than it would for other countries resulting in the problem being much worse.

    One poster above focused on a very important point and that is capital allocation. When an individual is allocating their own capital they are very vested in the decision; however, when the government does it they are not carefull because it is Other People’s Money. Accordingly, government spending is usually a very big misallocation in capital resulting in subpar returns. Over the long run this will result in a country also having subpar economic returns.

    Sorry, for so many posts.

    1. Tao Jonesing

      “When an individual is allocating their own capital they are very vested in the decision; however, when the government does it they are not carefull because it is Other People’s Money. Accordingly, government spending is usually a very big misallocation in capital resulting in subpar returns. Over the long run this will result in a country also having subpar economic returns.”

      What happens when you substitute “the government” with “a corporation” and “government spending” with “corporate spending?” Are you conclusions any less true? These days, large corporations, particularly publicly held corporations, aren’t managed for shareholders’ long term interests but for management’s short term interests.

    2. Ishmael


      My experience has been the difference between successful and unsuccessful corporations is how capital allocation takes place.

      Even if you are focused on short term returns for bonuses etc, you still want to make sure capital allocation is performed properly and with great diligence. A year from now you want a bonus also and really to get the stock going up so your options to pay out requires several quarters of improving earnings.

      The money that is being spent is still the Corporations and usually there is attention to this matter. Having been over FP&A for a very successful Fortune 500 company the amount of study we performed on capital allocation was extensive and strong accountability on how money was spent to ensure promised returns were received. On the other hand, walking into poorly ran companies, usually you can not find any analysis at all on how capital was spent nor any accountability for poor decisions.

  20. Adam

    I don’t mean this literally, but “It’s the debt stupid!”

    Households, businesses and soon the government are all carrying too much unproductive debt (debt that didn’t lead to income generation to pay for itself).

    Monetary Policy – Even if you could get the banks to lend, everyone has so much debt that they can’t service now you can’t expect them to take on more and service more debt. It wont happen. Monetary policy is doomed to fail, just watch the M1 Mult continue to decline – and if the FED was stil publishing M3 it too would be falling.

    Fiscal Policy – It’s the wrong medicine right now. It would be best used AFTER some massive debt reduction has occured or in conjunction. Without debt reduction first the best fiscal policy can do is prop the economy up. It can’t create a sustainable recovery because that requires investment and credit usage – but nobody can affort or risk credit expansion right now.

    No Stimulus – Well I have never advocated the liquidationist approach, but it does certainly gets rid of the debt problem.

  21. Jim

    Ed, your hope that “…government could add stimulus while simultaneously encouraging saving and deleveraging, reducing dependence on asset prices and allowing companies to fail,” was understandable.

    But it is now clear that this government is incapable of dispensing with crony capitalism. Where does this leave us?

    I am afraid that this situation now demands an analysis and a candid converstion which takes us beyond economics. Both the State (as presently configured) and the Market (as presently configured)–and the institutions and individuals involved in leadership roles in both spheres–have failed us.

    One part of this extended conversation might now revolve around a close examination of various cultural assumptions–for example, the belief that social/economic change (for good or ill) is largely the product of elite theorizing and elite authority vs. the opposite assumption that social ideas and change can, on specific historical occasions, eminate from non-elite sectors of the population.

    Is there a residual sense of character and poise still operable in the American population (as distince from its elites) that is capable of regenerating a democratic polity?

  22. Ishmael

    I am sorry, one other thought.

    One of the reasons this recession/depression occurred is that the debt of the nation as a whole reached a point where it can not be serviced and things have gone full stop.

    Much of the action to date has been to keep assets from dropping (we would not want deflation to set in) and becoming more affordable; however, we have had extensive job losses and reductions of lines of credit.

    Accordingly, this has caused the problem to grow worse. Assets prices have not declined much but income has so assets were even more over priced than they were when the recession started. We can not clear the problem. This was the reason that bankruptcy was put in place. Clear the problem and let things get moving again.

    In our cases the so called economic elites who have close ties to bankers would lose the shirt and would no longer be elites if we allowed prices to drop to an affordable level. Accordingly they are pulling all the strings they can in Washington to keep this from happening. Of course they front some poor home owner as the justification, but don’t kid yourself.

    The stimulus is working against us by making assets even more over priced compared to income and not allowing the system to self correct. This is how Japan ended up with a lost 20 years.

    1. Onlooker


      Please don’t be sorry. Your comments are excellent and right on point. I am completely empathetic to your frustrations here. It’s maddening to see what’s going on, and what led us to this point over the last 3 decades or so, with the last decade being the back breaking straw.

  23. kevin de bruxelles

    Why narrow the view to a roughly 30 degree field of vision with a limited discussion of fiscal vs. monetary policy when the US economy is hurting in all 360 degrees?

    On for fiscal policy, forget the stimulus. As our right wing friends always tell us; the government is the problem, and this has never been more true than today. Of course, just like on immigration, the right are happy to sit back and let the left take all the political hits for carrying out a policy (corporatism) the right really favours but is loath to admit publicly. The taxpayer approach towards the American government should be distrust and vilify. Every excuse possible should be found to cut government spending and revenues.

    As for monetary policy I would say credit is too easy and the fed target should be around 1% with no quantitative easing but I’m obviously just guessing here.

    These two above policies above would be admittedly deflationary but there are other more inflationary policies that could be encouraged to offset this downward tendency. For example stopping the pansy-assed policy of economic pacifism towards Asia. In other words, encouraging in every way possible an increase in US manufacturing at the expense of Asia in general and China in particular. Rebuilding a manufacturing capability is the most important economic long-term goal for the United States today. The freak show called Chimerica has to stop. America must manufacture more and China must start to consume. The US has to tools to make this policy work but fifth columnists on Wall Street, Hollywood, and Washington will resist this to the end.

    The other major policy shift would be to stop mass third world immigration into the US. This too should tend to be inflationary as working class men should eventually start to make up on the wages last over the past thirty years.

    Another move would be to stop the tend towards corporatism and eventually fascism. First there was a military / industrial complex, which at the limit has some historic logic. But then the corporations got into agriculture and demanded subsidies. Now the Wall Street / industrial complex is in full effect. Tomorrow the health insurance / industrial complex will rear its ugly head on the back of the Mussolini-esque health care bill that may pass Congress soon. All these trends need to be reversed but this may well take a revolution to accomplish since corporations are not likely to just walk away from government guaranteed profits combined with government assumed losses.

    Tied to this is a real reform to the health care system. This should be a very deflationary move since the US spends way too much per capita for crap health care. This is a difficult issue since many working class families are now surviving on the wife’s health care related salary while the husband’s construction related earning are non-existent. At least that is what I observed on a recent trip to California for visit with family and friends.

    All in all whether a policy is deflationary or inflationary should be secondary as to whether it is in the US economy’s long-term best interests. If GDP has to drop 10% in order to get the US house in order then so be it.

  24. Hugh

    By and large I agree with Ed. We cannot expect government to help us get out of this mess as long as it is controlled by the current elites who are using it to loot the country. On the other hand, government action, both fiscal stimulus, and I believe debt repudiation, is necessary for us to deal effectively with our financial and economic crises. I agree with those too who say we need to use stimulus to re-industrialize the country, creating stable jobs and a sustainable economy and environment.

    As I have often said, our elites have failed but more than this they not only stand in the way of solutions to our country’s economic problems they actively oppose them. In political terms, what this defines is a pre-revolutionary state. I know that such language will make many uneasy. After all, it is what we were taught from infancy: to glorify the Revolution, safely passed, but to abhor all others. And indeed revolutions are messy, often end badly or in civil wars, and should not be entered into lightly. But revolutions are also the logical consequence of elites that cannot govern but refuse to leave and give up power.

    Pre-revolutionary states do not necessarily lead to revolutions but they do create the foundations for them. The Great Depression was such a time and corresponds most closely to what we see now. FDR was able to co-opt and redirect the country’s revolutionary tendencies. But we have no FDR now nor even any on the horizon. I know the propensity is to say that it can’t happen here, or now, or again. But let’s face it after the Great Depression that’s exactly what people thought about financial meltdowns: Been there, done that, fixed it –except it did happen again.

    As long as our current elites remain in place, I think Depression is inevitable and revolution likely. Japanification is possible but given the degree of looting of the economy by our elites, this is becoming less likely. Sustainable recovery under our current elites is impossible.

    1. Ishmael

      Just more Keynesian claptrap.

      Right now we have 15 million or more illegal aliens here and who knows how many on H-1-b. Get rid of them and you will generate more jobs for Americans. Get rid of the extended unemployment and Americans will have to take those positions. When I travel the midwest I see a large number of white americans doing jobs that illegals do in California. That gets rid of the argument that Americans will not take those positions.

      With regard to H-1-b a big part of the arguments for these is because of the intellectual brain power these visas bring. Have you ever looked to see who are the biggest users of H-1-b’s? The Big 4 accounting firms so they can bring people in, work them like dogs and not pay them. If we got rid of H-1-b’s, wages would rise in those positions and Americans would take them.

      Once you have done these two items, then come talk to me about paying people to consume.

      1. Hugh

        Deport 15 million here, force millions to take poorly paying jobs there, you display the same casual callousness to the suffering of others that I find in so many current economists. Would you be so blithe and saying the same things if you or yours were part of those 15 million or if you had to make the choice between a job that didn’t pay a living wage and no job at all? What would be your preferred method of getting rid of 15 million people? cattle trains, mass arrests, concentration camps? What if Mexico closed its border? What would you do then? Have you considered how politically destabilizing to Mexico (and other countries) it would be to suddenly dump large numbers of immigrants on them? Or the economi effects of suddenly removing large remittance streams to these same countries? Seriously, if you could just wave a wand to do the things you suggest, why not wave it and create 15-30 million good, stable jobs in this country?

        1. Ishmael

          First, I started working when I was 13 and paid my way through college. No one has given me crap. For the last few years, I eat what I kill. If I find work, I do it and many times bring along others. I do not get up in the morning and say boo hoo no one has given me work. Many times I do the same work I did 25 years ago. I do not say that work is below me or I am too good for it.

          Second, as I said people in the midwest do those jobs, does that make me callous to say that people in California could also do them.

          Third, this country has had mass deportation twice in recent times. Once after WW1 and a second time under Eisenhower.

          Fourth, it is alot easier to come up with free lunch solutions. Once again, no pain. This is the reality. There is a fixed amount of wealth. That wealth can be allocated all sorts of ways. We can allocate in a systemic manner of working or by just giving it away. Printing of money and giving it away is devaluation and basically taking money from everyone who has worked to get it. Now I call that callous. As my Russian neighbor always reminds me — in Russia it was I will pretend to work and you will pretend to pay me. That is how it gets in a system you advocate.

          1. Hugh

            We all set great store by our personal experiences, but it is dangerous to generalize from them or base policy on anecdotes. You have an odd concept of time if you think recent includes events of 50 to 90 years ago. You might remember too that we had Jim Crow even more “recently” than either of these events. Just because something happened sometime in the 20th century is hardly a justification for its use now.

            You also ignore, again, any attention to the suffering of others. How convenient in that your solutions visit so much of it on them. Nor do you bother to address just how this mass deportation of yours would work or what its repercussions would be both here and abroad. Rather than be inflammatory, I would simply suggest that you reconsider what the real costs and consequences are for the ideas you suggest.

          2. Doug Terpstra

            “There is a fixed amount of wealth … We can allocate in a systemic manner of working or by just giving it away. Printing of money and giving it away is devaluation and basically taking money from everyone who has worked to get it. Now I call that callous.”

            Wealth is emphatically not a fixed, zero-sum quantity. Such a declarative statement reveals a very shallow old-school socionomic understanding of business alchemy and human capacity for creative innovation for true wealth creation. It does, however, match your hatchet-man “HR” mindset toward people. Cultures, societies, and civilizations do not become great and wealthy by mazimizing efficiency and Darwinian competition but by nurturing cooperation, empathy, trust, aspiration, art, beauty, philosophy, etc. Your worldview sounds like a dysfunctional dystopia of selfishness, a la Ayn Rand or Alan Greenspan.

        2. Mike in Fairfax

          Have you considered how politically destabilizing to Mexico (and other countries) it would be to suddenly dump large numbers of immigrants on them? Or the economic effects of suddenly removing large remittance streams to these same countries?

          Hmm. Funny. I want to hope this is sarcasm but alas, I don’t think that it is. I thought that the Fed, congress, etc. were responsible (to whatever degree) to US Citizens for the economic health of THIS country? But whatever, let’s bite and answer your question. What might be the effect of deporting the 15 million illegals and cutting off the stream of US dollars to Mexico (as its #2 source of money to the Mexican GDP)?

          MAYBE, just maybe, the Mexican people might demand that their government take steps to grow the Mexican economy without an economic policy of employing Mexicans anywhere but Mexico.

          Maybe Mexicans finding jobs in Mexico would result in Mexico having more complete family units.

          Maybe Mexican families would decide they don’t want a government afraid of the drug cartels?

          Maybe more Mexican workers in Mexico would result in Mexican entrepreneurs starting jobs in Mexico?

          Maybe these Mexicans who have tasted US representative gov’t (even being allowed to vote as illegals!) might get the idea that it’s time for a change to the Mexican constitution so that foreign companies will be able to help them get to their deep water oil reserves (oil still being the #1 source of Mexican GDP but falling fast due to deleting land oil deposits and lack of deep water drilling technology). Maybe.

          Either way, it isn’t the responsibility of the US gov’t or people to concern themselves with “What’s best for Mexico?” As fate would have it, Mexicans have their own gov’t for that very purpose.

          1. Hugh

            And Maybe pigs would fly. The world is not a Risk board. Historical realities can not be erased today and rewritten tomorrow. Policies do not affect widgets but people who bleed and know pain. It is curious especially in this holiday season how quickly and effortlessly that realization goes out the window. It is doubly so when you consider so many of your maybes in the light of our own unemployment levels, our own crisis in representative government, and our own involvement in Mexico’s drug problems. Just because you can’t be bothered with considering the consequences of the policies you support doesn’t mean that those consequences don’t exist or can be safely ignored. Bush is an object lesson in this kind of approach, and its shortcomings. You might consider that much of the reason why we are in the predicament we are in is precisely because of this kind of “consequences don’t matter” thinking.

          2. alex

            Hugh: “Policies do not affect widgets but people who bleed and know pain.”

            Mike in Fairfax is talking about enforcing our existing, decidedly non-draconian immigration and employment laws, not lining people up against a wall and shooting them. And I think his basic point is right: the primary responsibility of the US government is towards its citizens. Given the choice between an unemployed illegal alien and an unemployed American worker (by which I mean legal permanent residents as well as native born and naturalized citizens) I’ll take the former.

            The fact that suddenly deporting 15 million (or whatever today’s estimate is) illegal aliens would have a horrible shock effect is not a concern because we can’t do it anyway. If nothing else we don’t have enough buses. Even deportation may not be important as long as we enforce our employment laws. No job and people can find their own way home (this is already happening to a certain extent due to the bad economy). A few months ago there was a major enforcement action at American Apparel in LA where they had to lay off 2000 people (25% of their workforce) because they were illegal. In this economy I’m sure they’ll have no trouble finding 2000 legal replacements. I thought this Obama administration action was better than Bush’s approach of high profile raids with zillions of cops, detaining people for questioning, etc. Unfortunately I haven’t heard of it being done consistently.

            The H-1B guest worker program is another insult to American workers (defined as before). Even in the best of times there was no justification for it, but it’s beyond absurd now. Simply stop issuing H-1B visas. The L-1 guest worker program is also ridiculously abused, and rules should be tightened and enforced. The bottom line is that there is no shortage of IT people, programmers, engineers, etc. in the US, and there wasn’t even when times were good. The only justification for these guest worker programs were the attestations (unbacked by any evidence) of Microsoft, IBM, etc. saying they had trouble hiring. Yeah, right, and the wage depressing effect wasn’t what they wanted. Google “Norman Matloff” for the whole scoop on this. He’s a CS professor who’s been writing about it for years, and he backs his assertions with very solid evidence and statistics.

            The H-1B and L-1 visa programs also play a large role in offshoring. Amongst the biggest users (abusers) of these programs are offshoring giants like Tata.

  25. Not DownSouth

    Walk left side, safe.
    Walk right side, safe.
    Walk middle, sooner or later, **squish** get squish just like grape.
    ~~Mr. Miyagi

  26. Weapons of Mass Deconstruction

    Ed –

    I thoroughly enjoy reading your posts. However, I simply do not understand how those who claim to have studied Austrian economics can posit that deflationary credit contractions are not self-equilibrating. History, as well as general human habits in the way of buying patterns, does not support that view remotely.

    You have frequently mentioned – rightfully so – that interventions, whether monetary or fiscal – create malinvestments. Horrible malinvestments. They extend the capital structure and factors of production, which do far more harm than temporary good.

    Without getting into the minutiae of detail, malinvestments must be allowed purged from the system, and even attempts at stabilizing the process artificially mitigate the benefits of that required deleveraging by adding more leverage back in and creating more misallocations of capital.

    This is going to end in tears.

    1. Edward Harrison Post author

      The concept that economic systems are self-equilibrating is a neoclassical fallacy. Anyone who has studied economic history knows that downward spirals are the norm. Yet, neoclassicals try to show horn this ivory tower view into the debate by claiming government intervention is responsible for the lack of equilibrium.

      1. Andrew Bissell

        Anyone who has studied economic history knows that downward spirals are the norm.

        Really? The “downward spiral” theory must imply that, absent government intervention, the slightest downtick in the economy would lead to an inexorable march back to the Stone Age, absent government intervention. Does economic history really support such a thesis?

        Looked at from another angle, if the economy is truly characterized by endlessly self-reinforcing feedback loops, why do booms ever end?

    2. Edward Harrison Post author

      I would add this is the core of Richard Koo’s thesis i.e. that markets do not always go back to equilibrium. The balance sheet depression is one in which a paradigm shift occurs and everyone is looking to deleverage and pay down debt. This is a downward spiral, not an equilibrium.

      1. Gaucho

        Ed, excessive leverage created asset inflation. how can we expect to have a deleveraging process without deflation? people talk about a deflation spiral as a straight way to zero. I’m from Argentina so I’ve seen a few debt crises. we had deflation in a big way and that caused massive debt defaults, the same debt that was created by excessive leverage. But I can assure that there’s always a bottom and it’s not zero. painful but relatively short process. after 2 or 3 years, you can resume growth with a clean balance sheet. Given the pain involved, the only stimulus I support is extended unemployment benefits and healthcare for everyone, but that’s all, then I’d rather let things play out.

        1. alex

          “how can we expect to have a deleveraging process without deflation?”

          Are you talking about asset deflation or CPI deflation? I agree we can’t realistically escape asset deflation. CPI deflation is another matter though. Since we had aseet inflation without much CPI inflation, why can’t we have asset deflation without much CPI deflation?

          “we had deflation in a big way”

          Again, asset or CPI deflation?

          1. Gaucho

            when I’m saying “we had deflation in a big way” I was referring to the crises in Argentina.
            but going back to your question, with so much slack in the economy, I don’t see how we can escape CPI deflation. the only reason we’re now trying to fight deflation is to prevent the increase in the real value of debts at the cost of destroying the currency. I think it’s ridiculous, rather than protecting those debts, they should be written off (Credit Writedown…) and let asset values deflate so those people with capital here and abroad can pick up the assets and recapitalize the balance sheets. with this monetary policy, we are just killing huge USD-denominated savings sitting abroad that would rather be invested in high quality US assets rather than in overinflated emerging mkts (e.g. Russia or Brazil). Reinvestment of savings is the best (and the largest) stimulus we can have.

          2. alex

            Gaucho: “the only reason we’re now trying to fight deflation is to prevent the increase in the real value of debts”

            Not a minor reason. Debt-deflation spirals are nasty and not just a theoretical concern – we had them during the Great Depression. I don’t know enough about Argentina to say if it was similar.

            Debt-deflation spirals also adversely affect people who didn’t borrow over their heads or buy horribly inflated assets. I think asset deflation (housing) is necessary, and should be done through write-offs and renegotiating principal amounts, but serious CPI deflation is another matter.

            “at the cost of destroying the currency”

            I don’t think we’re destroying the currency (yet).

            “Reinvestment of savings is the best (and the largest) stimulus we can have.”

            Invest them in what? Absent demand no rational person is going to make productive investments.

          3. Gaucho

            Alex, the debt will have to be written down, you’re not going to see any pick up in demand until the consumer repairs his/her balance sheet. you can do it two ways: short and painful as in Argentina or take the long road as Japan did. the japanese economy sucks but the last 20 years haven’t been that bad for the average guy, unemployment was only 4% there. Interest rate manipulation to encourage people to borrow or refinance is not gonna work. Just see how bad the loan mods are doing. if you ask around, i’m positive 99% of people don’t want to be Japan and, without going to extremes of emerging mkts adjustments, people are willing to take the hard medicine. That is what I always loved about this country (we screwed up, let’s fix it, and then let’s see who goes to jail). people want to go back to the basics, but politicians just forgot what made this country great.
            And with regard to currency, the Fed’s goal seems to be 5-6% inflation to liquidate the debt problem. So far, they failed because the deflationary forces are just too strong. maybe Heli Ben becomes creative again and decides to move excess reserves from the banks to the checking accounts of people. If we’re giving money to banks and they don’t want to lend, well, let’s skip the banks, right? And then, he will achieve his goal.
            All this could be avoided with more credit losses to accelerate the consumer balance sheet repair process. the cost is huge, but it’s mitigated by bank shareholders and bondholders taking losses first and then the govt. covering the capital gap. but the Administration forgot the basic principle that in a crisis there are no winners, only losses to be spread out amongst all participants. I’m afraid the US is losing its way, which I guess it’s part of the normal evolution of every single great country in history.

          4. pebird

            Deleveraging is made of two components: 1) market-driven behaviors, 2) legal reconciliation. Let’s not forget that the Administration/Fed has done its best to keep 1) from happening in a fair manner, it also has failed in its duty to investigate and prosecute.

            Just supporting a market response without the necessary legal activities gets us to a place we probably don’t want to be real fast.

    3. alex

      “I simply do not understand how those who claim to have studied Austrian economics can posit that deflationary credit contractions are not self-equilibrating”

      Q: What happens to an economist when you throw him off a 10 story building?

      A: He reaches equilibrium.

      Less jovially, who says that an economy can have only one stable equilibrium point? I think this is a faulty and generally unstated assumption of both neoclassical and Austrian economics (actually I thought Austrians didn’t believe in equilibrium). There is no justification for this assumption, either mathematically or empirically.

      Hence the joke. When the economist goes splat he will be in equilibrium every bit as much as when he was standing on the roof.

      Just as importantly, the path to “equilibrium” is as important as where the equilibrium is. Whatever you think of Keynes’ other idea, I think the full quote is telling:

      “The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

  27. DoctoRx

    Nice review.

    IMO all stimulus is local. In other words: If Government can deficit spend with a high ROIC, great. If it’s just the ridiculous extend and pretend Fannie/Freddie/FHA/Citigroup socialize the losses/private gains stuff, give me an Austrian.

    In yet other words,as Team Bill Clinton might have said: Its the specifics, stupid, not the theory.

  28. But What do I Know?

    As far as the cronyism issue, I seems to me that this is the way that all successful societies fail–because the people at the top do not believe that fundamental change (which would affect their top dog positions) is necessary. It is difficult to get a man to understand something, when his salary depends upon his not understanding it, as Upton Sinclair put it. And so solutions are papered together and nothing is fixed until changed is forced on the society from the outside, usually through defeat in war. Perhaps there is no solution to this problem, which lies at the intersection of human nature and organizational structures.

    1. Mike in Fairfax

      And isn’t it horrific that actually cutting the size of government (not slowing the rate of increase, but cutting) is never really discussed as part of the solution? The current health care scam is a total lie that will balloon the size of gov’t and your dependency on it, not decrease it. We have something like 700 Dept. of Agriculture offices out there. Do we need them all? Can’t we admit that the ethanol program is a sop the farmers and not a solution to any fuel problem? Can’t we agree that although the Medicare Part D (as in DEFICIT) was “just a down payment” to Ted Kennedy, it was a massive mistake of “me-tooism” by republicans that should be corrected for immediately?

      I cannot believe this country cannot trim actual gov’t spending by 2% a year for 5-10 years and still not provide everything the constitution requires it provide. I say we give it a try.

      1. alex

        “I cannot believe this country cannot trim actual gov’t spending by 2% a year for 5-10 years and still not provide everything the constitution requires it provide.”

        Of course it could, given that the Constitution requires the federal government to do very little. The questions are whether it’s desirable and what specific things should be cut.

        “The current health care scam is a total lie that will balloon the size of gov’t and your dependency on it, not decrease it.”

        As written (at least the Senate version) the main effect will be to enrich insurance and pharmaceutical companies.

        “Can’t we admit that the ethanol program is a sop the farmers and not a solution to any fuel problem?”

        Gotta agree there.

        “Medicare Part D … was a massive mistake … should be corrected for immediately?”

        The big mistake in Part D was the language that specifically prohibits the government from bargaining over drug prices. Just a big fat wet kiss to the pharmaceutical companies. I’m enough of a “socialist” that I don’t mind helping to pay for granny’s meds, but I want them at Canadian prices. If big pharma can sell them profitably in Canada (and every other country other than the US) for a lot less than they cost here, I want Uncle Sam to get the same price.

        1. Mike in Fairfax

          I’m very uneasy with anything that lets the gov’t set specific prices, and I see “big pharma” as less of a criminal element than some here obviously do. There can be no denying that it costs MASSIVE amounts of money to bring a new drug that works to market. Part of the problem is that we don’t have the WTO working for us. Go figure.

          Part of the reason drugs cost so much for us is that Big Pharma actually gets bent over a barrel in the EU and other places because they aren’t allowed to enter those markets unless they DO NOT pass on development costs. Foreign markets say “We’ll let you charge for you marketing costs, but we’re not picking up the development costs”. Well, those costs are huge and they rest on the shoulders of US citizens alone.

          My solution would be that the US get WTO or whatever body needs to be tapped to protect our interests in selling our drugs and recuperating all costs.

          But also, the US needs to have a standing rule: “The gov’t doesn’t get involved in drug costs or fixing markets. But no US citizen is going to pay more for a US developed drug than the lowest paying customer you make a deal with. In other words, aside from charity like AIDS drugs to Africa, if you make a deal to sell Viagra for $0.50/pill with the EU, that’s the highest price you can charge for it in the US. Make the deal, don’t make the deal. We don’t care. Just know that the US consumer automatically gets whatever best deal you make with anyone else.”

  29. Ishmael

    In general, I believe we had a credit bubble that was also hiding a growing government (the least productive part of our society) problem which has been sucking the life out of this country.

    The real point of “But What do I Know” is that attempting to run all of this from Washington DC and a large central government is a ueseless exercise and all stimulus is sucked off by cronies before it ever gets to the people. Even with state and local government it is near impossible to deliver anything to the people due to the corrupt government that is in place.

    Are we not in agreement that large socialist structures fail. Didn’t the Soviet Union and China show that. Why do we have to reentertain economic models which have proven themselves to be solid failures? The purpose of the US government is to govern not run the economy. Governments have proven themselves to be failures at economic issues multiple times over.

    Let me throw this out on the stimulus. Right now this country has somewhere in the range of $50 to $60 trillion of assets. Let us be generous as hell and give the governments a worth of $20 trillion. Liabilities on the other hand far exceed that. SS is $20 trillion. Medicare is at least $60 trillion and another $10 trillion for the pharma bill that idiot George passed. Then there is the $12 trillion national debt and who knows how much for state debt. On top of this there is the untold trillions of unfunded pensions costs for federal, state and local government employees and the military. If you put this in a balance sheet it is quite obvious we have a net deficit.

    To stimulate we need to borrow. Further borrowing leads us into a larger net deficit. Is it not morally wrong for this country to borrow money it obviously can not repay! I just do not see how digging a deeper hole helps anything.

    1. Hugh

      “Are we not in agreement that large socialist structures fail.”

      No, many Western European countries are far more socialist than we are and are doing substantially better by their people than we are by ours. Given events of the last 2 years, it would be far closer to the truth to say, “Are we not in agreement that large capitalist structures fail?”

      1. Doug Terpstra

        Excellent question, one whose answer is unfolding as a grisly slo-mo train wreck.

        It’s rather hard to see much difference at this point between totalitarian communism and rigged market capitalism. It seems, as Minsky noted, capitalism carries in it the seed of its own destruction perhaps like living organisms have termination genes. Libertarians seem incapable of connecting freedom and enlightened self-interest with, in the absence of regulation and progressive taxation, its inexorably evolution toward concentrated power (corrupted) and then absolute power (corrupted absolutely), aka fascism. Game over.

        1. alex

          “It’s rather hard to see much difference at this point between totalitarian communism and rigged market capitalism.”

          Indeed, Russia showed how easily one can morph into the other.

          Not to join the nihilistic “they’re all the same” crowd. Last time I checked (and thankfully for this blog) they’re not arresting Americans for criticizing the government.

          Bottom line is that pure socialism, pure capitalism and rigged capitalism are all pretty bad. I’ll state my belief in reasonably regulated capitalism with a fair sprinkling of government services thrown in. I think that’s about as controversial as motherhood and apple pie, but some people always enjoy arguing for, or making strawmen of, the extremes.

          Pragmatism is ugly – it abhors ideological purity.

      2. Ishmael

        Hugh — Being the whinny, yelppy, socialist/communist that you apparently are I would expect no less of an answer from you. Look at the PIIGS country and they are all failing. France has done no where in years. UK is failing and the only thing that props it up is North Sea Oil. How about the Soviet Union as a failure.

        No wonder we can go no place with all the socialists coming out from under a rock when ever they get a chance.

        The problem with this country is the economy is too controlled by the government. Fannie, Freddie, Gennie. Military industrial complex. Federal Reserve. Federal, state and local governments. That is all easily more than 50% of the economy. We are slipping into the same problems as the Soviet Union.

        One other thing on being callous. One of Obama’s problems as well as Jimmy Carter and any other liberal that has been voted into office is he can not make a tough decision. They are afraid they will hurt some ones feelings. Waaaaahhh, he is being mean.

        1. Mike in Fairfax


          Oh I don’t know. Socialism seems to be working out OK for Cuba. Why, just the other year there was a documentary by a guy named Moore on the wonderful health care system they provide for Cubans. And they are so filthy rich that virtually all Cubans can afford antique US cars! It’s an amazing story.

          And how about Greece? Things seem to be working out just fine for them. They are dancing in the streets almost daily now. Why people would dance with signs is a mystery to me, but who am I to criticize such a historic culture?

  30. Mike in Fairfax

    In a “normal” recession I would go with choice #1 hands down. It’s called capitalism. Failure is an opportunity to learn, creative destruction, yadda yadda yadda. Reagan had it right. The gov’t is the problem, not the solution. Most of the bubbles that popped and caused recessions were created by one part of the gov’t or another.

    In this particular instance where the problem lay in the very infrastructure that lets capitalism work, i.e., the banking system, I can’t fault the panic that resulted in TARP etc. Not initially anyway. Lehman was a terrible mistake. I don’t fault the logic that a line needed to be drawn, but Lehman wasn’t the place for the financial bailout Maginot line!

    Having said that, by the time the dust settled it should have been clear that the auto bailout, giving AIG 100% on the dollar for their debt, forcing “mark to market” were all huge mistakes. With respect to “mark to market”, I think we can agree “mark to model” was just a fairy tale worthy of Walt Disney, especially when everyone got to use their own model! But changing the rules all of a sudden was a disaster. They needed some Faustian bargain like a “gradual mark to centralized model” or “gradual mark to 10 year market value” or something.

    The success of stimulus as a way out of recession is dubious. The high level of waste, corruption and inefficiency a proven fact. But this particular “stimulus” didn’t have a shot in hell because the goal was never to stimulate the economy, it was to stimulate the growth of big, centralized government controlling every aspect of your life. They probably figured “this recession will go through its life cycle as all do, we’ll come out of it after we tip-toe into socialism and forever more the cause/effect of socialism to a healthy economy will be in the history books!” Wrong. It wasn’t/isn’t that type of recession.

    But the biggest problem with any solution to this recession is that no solution has actually gotten the “Troubled Assets”, the TA part of TARP, off of the books. The holders are still hoping for the lotto ticket that these assets actually rise in price before they need to divest of them and have a Come to Jesus accounting moment. Nothing is forcing them from their virtual reality either. Which is why they quake at the thought of a commercial real estate driven double dip recession.

    The big banks, insurers, foreign investors etc. still have the housing poo on their books, and the smaller banks have much of the commercial real estate loans that will default in the future. The gov’t hasn’t solved the real problem so the same trigger can set off another dip very easily. Good thing we have all those “green” jobs to bring us out of it!! We and Spain. Muy verde.

  31. Matt Jolley

    Debt driven consumption is the real bubble. Neither monetary nor fiscal policy address the consumption that has become almost 70 percent of the US economy. How to wean US consumers from our least beneficial activities should be the question. A national sales tax may be the answer the politicians come up with.

  32. alex

    Something missing from this debate is any mention of undoing the yuan peg and in general reducing the exchange rate of the dollar to reduce our trade deficit. Somewhat inflationary, but it would be good for manufacturing (and is a necessary long term step anyway).

    1. Mike in Fairfax


      I was shocked that the original post had virtually no mention of currency exchange rates. I agree about China but we’re not in a position to force them to do anything and if they don’t keep 8+% growth their leaders fear for their political (and physical?) lives over there. Right now, they are an export economy so the cheap yuan works for them in the short run.

      The plus side is that they know they need to migrate to a more balanced economy, but they’re going to do it as it suits them, not us.

      The “proper” level of the dollar is a tough thing. You’ve got people like Kudlow who insist that we must have a “strong dollar” because no economy has been strong for long on a weak currency. Maybe. But “strong” to me is relative. I don’t see how a country with a currency so strong that it gets the short end of the trade stick with virtually every trading partner is very strong at all. How long do we need to carry the frickin’ world economies in this sick game of us spending money we borrow from them on their goods?

      The currency needs to be “weak” enough to enable a certain level of exports but “strong” enough where it provides as much of the benefits that people like Kudlow yearn for. That level changes over time as global currencies change.

      One thing’s for sure. We spend too much money, including money that we don’t have (people and gov’ts) and they generally save “too much” in China. Of course, they do it because China doesn’t provide the safety net we do, so the Chinese people are actually pretty dang smart! We should be so smart.

  33. Siggy

    I wonder why we talk about stimulus at all. Where will the funds for the stimulus come from? The government does not have a retained earnings account. Its singular asset is its power to tax. Thus, anything that is discussed regarding quantituve easing and/or fiscal policy is ultimately funded by either direct taxation, or the indirect taxation of inflation. And by the by, inflation is just another way to say loss of purchasing power.

    As to the banksters, well now that is how our government has failed us. The lack of prosecution of financial frauds is stunning.

    As well noted above, there is easy no painless easy out of dilemma.

  34. Frodo

    It seems we’ve entered into a cycle of increasing frequency and amplitude in which government monetary and fiscal steps taken to ‘manage’ or recover from each recession temporarily alleviate some of the symptoms while laying the groundwork for the next (sooner and more serious) crisis. This time around, the risks seemed more systemic and the response has been correspondingly more dramatic. Doing nothing in the face of systemic fragility is/was not an acceptable options for a government, but we’ve probably bought ourselves a shorter period (2-5 years?) before the next crisis – which may seem even more frightening. Big pots of money create big problems. Doing nothing is not acceptable. Doing ‘something’ creates a bigger problem later. Ouch.

  35. sean

    Here in Ireland we are in the midst of a deflationary depression (the economy has dclined by more than 10% since this crisis began).

    There has been no monetary stimulus and a negative fiscal stimulus(Tax increases,imposition of levies and Public sector pay cuts,cutbacks in capital expenditure by government).

    The problem with the above is that real private and public sector debt is increasing rapidly(This would be so if even the nominal debt remains the same).But we also ahve a massive current account defecit of nearly 13%.

    The prevailing mood is one of despondency with a festering anger.I see trouble ahead.

    1. Mike in Fairfax


      You poor b@stards in Ireland got done in at least in part by the EU. The EU had a big hand in killing the Celtic Tiger and it’s a damned shame. True, you had your own housing bubble/bust like the rest of us, but the EU one size fits all approach to very different countries is a horror movie. I feel for you. That plus the attempted shot to the economic head with the entire AGW scam and all its carbon offsets etc. is just sickening to watch.

      It’ll take some time for the current mess to unwind, but I would count on better times ahead for Ireland.

  36. RN

    You have an excellent understanding of the “tyranny of the double entry accounting system” and its relevance to macro economics. The next logical conclusion is “fiscal policy only” for lasting economic recovery. Monetary policy can only provide temp relief but not long lasting solution.

    There are two unfortunate parts to the “fiscal policy only” solution.
    (1) Cash for clunkers and extended unemployment benefits provide temp relief and according to me, they are NOT part of fiscal policy responses. They have zero multiplier effect. On the other hand, investment in public infrastructure, research or public education are part of the fiscal policy solution.(higher multiplier effect). For example, integrated public transport infrastructure investment in the coastal areas is a low hanging fruit, which can provide ample job opportunities, alternative modes of transport, less dependency on foreign oil and reduced environmental pollution.
    Unfortunately most of economists do NOT understand this distinction or do not articulate that understanding accordingly. For example, James Galbraith has clarity on this. Paul Krugman does not seem to have this clarity (probably because Keynes did not make any distinction between different fiscal policy alternatives).

    (2) The second problem has to do with how the Congress operates. As you rightly pointed out, lobbies and special interests play major role in the fiscal policy decisions. But this has nothing to do with macro economics per se. It has more to do with lack of adequate checks and balances in the political system. This does NOT negate the role of fiscal policy solutions.

    I fully understand your disillusion with the current debate about fiscal policies. As a result, if you are “moving away from stimulus happy talk to focus on malinvestment”, I am sure you will come across ample opportunities to highlight sensational topics which can give a big boost to your web site ratings. But it will very little to the purpose for which you created your blog.

    1. Mike in Fairfax

      There are two unfortunate parts to the “fiscal policy only” solution.
      (1) Cash for clunkers and extended unemployment benefits provide temp relief and according to me, they are NOT part of fiscal policy responses. They have zero multiplier effect.
      On the other hand, investment in public infrastructure, research or public education are part of the fiscal policy solution.(higher multiplier effect). For example, integrated public transport infrastructure investment in the coastal areas is a low hanging fruit, which can provide ample job opportunities, alternative modes of transport, less dependency on foreign oil and reduced environmental pollution.

      I agree, but none of that was going to have money spent on it with the immediacy that the financial crisis required. And you one wants to put as many people to work doing that sort of thing, then mandating union wages for these projects when there is a flood of qualified people to do the work seems, well, “counter-intuitive” to say the least.

      Also, this particular approach MAY have benefits for the current crisis because a large part of the unemployed happened to have skills at least in the construction field. The new construction jobs, however, don’t do a damned thing to the former Lehman employee or real estate agent. Future recessions may get almost no “oomph” from construction projects.

      ( just testing something here — ignore )

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