Wednesday, April 3, 2013

The Economy: What Should Obama Have Done?

Obviously, all is not well with the economy.  The recovery from the Great Recession has been agonizingly slow.  But why?

In the American Spectator Peter Ferrara puts it all down to Keynesianism.  But I think that is too simplistic.

There are three analyses out there that claim to account for the failure of Obamanomics:
  1. Not enough stimulus.
  2. Not enough tax and spending cuts.
  3. Don't be so impatient.
Reason One is the Keynesian response, that government spending (and cheap money) kick-starts the economy, and the Obama stimulus wasn't enough.  Conservatives like Ferrara say that Keynesianism didn't work in the Great Depression and it won't work today.  But in fact it did work, for a while, with 12 percent real GDP growth in the election year of 1936.  The only thing was that after the stimulus was removed, in 1937, the economy crashed into the Recession within a Depression.

The real point of Keynesianism is to borrow money to keep things going, in the hope that the economy will recover and lift all boats.  It's a short-term thing, for a year or two.  Obviously, it hasn't worked out over the longer term, as in four long years of subnormal growth.

Reason Two is the supply-side response, that government spending and taxes add up to nothing more than a burden on the economy.  So the sooner you remove the burden, the better.  Also, the tax system naturally tends towards increasing complexity and carve-outs for special interests, so the sooner you chop that stuff away the better.

The only caveat is that you probably don't want to cut spending until the economy has clearly turned the corner.  We do not mean here that unemployment is back down to 6.5 percent, as the Federal Reserve currently proposes.  We mean that you don't start cutting spending until the risk of meltdown has clearly ended.  In the current context, that would be about January 1, 2010.

Reason Three is the argument of Reinhart and Rogoff in This Time is Different.  They argue that after a major banking crisis it takes about six years for the economy to shake off the doldrums.  That's because it takes that long for all the underwater debtors to de-leverage, either by paying down their debts or by going broke or a combination of the two.  You can't have a vibrant economy when a ton of people have questionable credit: counter parties can't exactly be sure how "sound" they are, and the debtors themselves are constrained by their lack of equity.

What about Obama?  Let's give him the benefit of the doubt.  The Great Recession was worse that the 1980-82 recession because of the banking and real-estate meltdown.  So it's misleading to task him with the stunning growth of the Reagan years.  But almost everything Obama has done has retarded the recovery.  Here would be my list of stimulus policies:
  1. Immediate cut in individual and corporate income tax rates followed in about two years by cuts in deductions and credits.  Temporary cuts in the business side of payroll taxes.
  2. Immediate cuts in crony-capitalist spending followed by real entitlement reform in a couple of years.
  3. A "bad bank" to take up all the underwater mortgages, and thus get the banking system healthy.
  4. Programs to float the underwater mortgages as quickly as possible.  That would be by both encouraging people to abandon their underwater houses instead of hanging on like grim death, and also to sweeten the pot by writing mortgage principal down.
  5. A general pruning of government spending.
Notice what we are doing.  We are changing the rules now, and cleaning up the garbage later.  We are recognizing that, after a big financial crisis, we are poorer and can't afford the luxury of all those big government programs.  Something has to give.  And we are doing positive things to repair the credit system.  A credit system is healthy when a) nearly all debtors are making their payments, and b) nearly all debtors are above water.

Note that Obama is pretty well 0 for 5 on this program, although he has done some muddy things to write down mortgages (good) while hindering the banks from foreclosing on non-performing loans (bad).  It's not surprising that the result is a F grade for economic policy.

If we had a mainstream media worthy of the name we would know all this, and the whole nation would be demanding a practical and pragmatic economic policy.  But we don't, so the economy suffers.  

In the long term, it probably doesn't matter.  The American people will eventually turn against Obamism, not because they understand the president's mistakes but because they will know that it didn't work.  

But we could have saved a lot of suffering with better policies to get us out of the worst economic crisis in just about anyone's lifetime.  So far.

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