August 15, 2011


Fixing the economy: We got it wrong: Our economic issues are worse than expected, and our solutions haven't worked. We need to start anew. (James K. Galbraith, August 15, 2011, LA Times)

The sensible thing would have been to paint the bleakest possible picture, emphasizing the extraordinary crisis, and so justify the largest possible policy action. Then if things turned out all right President Obama would have gotten credit, and any excess actions could easily have been cut back. Instead, the president set himself and his policies up for blame.

Obama's approach contrasts sharply with how President Reagan handled the recession of 1981-82 -- with massive tax cuts enacted in 1981. I did not like Reagan's tax cuts, but everyone could see that they implied a truly massive stimulus. This was politically smart, as Reagan's reelection proved. And when the message had been delivered, the cuts were trimmed in 1982, 1984 and 1986.

Obama's economists had more hubris and less ambition than Reagan's. They thought they could predict events accurately and put just the right policies into place. And that was before politics interfered, cutting the actual package to well below what Romer thought necessary. Larry Summers, however, was later quoted saying that he still thought the stimulus was about right, which raises the question: Why didn't it work as planned?

In fact, stimulus alone was never going to bring recovery. This crisis was caused by financial collapse, rooted in massive banking fraud. The financial system is our economic motor and when it fails it cannot be revived simply by pouring money on it, any more than a wrecked reactor can be restarted just by adding fuel. Team Obama faced a situation not seen since the 1930s -- a worldwide banking meltdown. The financial system needed to be rebuilt -- and it still does. But Team Obama chose to overlook this.

The result was debt-deflation. Falling asset prices tipped more and more households into insolvency, business stagnated, tax revenues dropped, states and localities cut their budgets and deficits widened.

Had we simply paid off all the subprime mortgages the fraud wouldn't have mattered and the poor would be solvent.

Posted by at August 15, 2011 8:00 PM

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