February 14, 2011
THE TOOLS DIDN'T FAIL, WE JUST LOST FAITH IN THEM:
Rethinking the Great Recession (Robert J. Samuelson, Winter 2011, Wilson Quarterly)
The boom did not begin with the rise of home prices, as is usually asserted. It began instead with the suppression of double-digit inflation in the early 1980s, an event that unleashed a quarter-century of what seemed to be steady and dependable prosperity. There were only two recessions, both of them short and mild. Unemployment peaked at 7.8 percent. As inflation fell, interest rates followed. The stock market soared. From 1979 to 1999, stock values rose 14-fold. Housing prices climbed, though less spectacularly. Enriched, Americans borrowed and spent more. But what started as a justifiable response to good economic news—lower inflation—slowly evolved into corrupting overconfidence, the catalyst for the reckless borrowing, overspending, financial speculation, and regulatory lapses that caused the bust.In some ways, the boom-bust story is both more innocent and more disturbing than the standard explanations of blundering and wrongdoing. It does not excuse the financial excesses, policy mistakes, economic miscalculations, deceits, and crimes that contributed to the collapse. But it does provide a broader explanation and a context. People were conditioned by a quarter-century of good economic times to believe that we had moved into a new era of reliable economic growth. Homeowners, investors, bankers, and economists all suspended disbelief. Their heady assumptions fostered a get-rich-quick climate in which wishful thinking, exploitation, and illegality flourished. People took shortcuts and thought they would get away with them. In this sense, the story is more understandable and innocent than the standard tale of calculated greed and dishonesty.
But the story is also more disturbing in that it batters our faith that modern economics—whether of the Left or Right—can protect us against great instability and insecurity. The financial panic and subsequent Great Recession have demonstrated that the advances in economic management and financial understanding that supposedly protected us from violent business cycles—ruling out another Great Depression—were oversold, exposing us to larger economic reversals than we thought possible. It’s true that we’ve so far avoided another depression, but it was a close call, and the fact that all the standard weapons (low interest rates, huge government budget deficits) have already been deployed leaves open the disquieting question of what would happen if the economic system again lurched violently into reverse. The economic theorems and tools that we thought could forewarn and protect us are more primitive than we imagined.
The beginning of the long boom was tied not just to to the defeat of inflation by Margaret Thatcher, Paul Volker and Ronald Reagan, but to the rise of transparent markets, free trade and free movement of peoples. The recession came when central banks panicked about inflation, bankers were allowed to disguise risk, free trade expansion stalled out, and the US congress became nativist. Getting our mojo back is actually pretty easy.
