Letter from an Economist
John Birchall
20 Oct 2008
The time has come to examine what the financial crisis has done to the "real" economy, for it is this that will influence jobs, peace, prosperity and so affect all people, wherever they may live, says UK economist John Birchall.
‘Let’s get real’
The majority of us will have been watching the roller coaster that is known as the stock market as it plunged and then moved dramatically upwards taking with it pundits, experts and all those who have promoted unregulated capitalism. For many it was interesting spectator sport and may even have caused some concerns about pensions and the value of one’s personal assets.
However, it is now is the time to return to some normality and think what is happening to the "real" economy, for it is this that will influence jobs, peace, prosperity and so affect all people, wherever they may live.
World trade
After billions of dollars, euros and pounds have been pumped into banks and financial institutions across the world, it's now clear that rescuing the banks is just the beginning: The non-financial economy especially that of the US, which is the main driver of world trade, is also in desperate need of help.
For quite a large number of economic experts that above statement will mean that they will have to put some long-held prejudices aside. In the United States, it has been politically fashionable to rant against government spending and demand fiscal responsibility. The free marketeers may have to accept that increased government spending is just what the doctor ordered, and concerns about the US budget deficit should be put on hold.
Basic Economics
Let’s look at some basic economics. Just this week US retail sales have fallen dramatically and so has industrial production. Unemployment claims are at steep recession levels, and the Philadelphia Fed's manufacturing index is falling at the fastest pace in almost 20 years. All signs point to an economic slump and it may be a long one.
It is not easy to assess just how long and deep the downturn will be but the US unemployment rate is already above 6% (and broader measures of underemployment are in double digits). Across the EU unemployment is starting to rise and this is especially pronounced in Ireland and Spain where a property-led boom has now started to collapse.
'Lost decade'
Perhaps we should think about the last recession, which followed the bursting of the late-1990s technology bubble – the so-called dot.com boom and then bust. On the surface, the policy response to that recession looks like a success story. Although there were widespread fears that the United States would experience a Japanese-style "lost decade," that didn't happen: The Federal Reserve was able to engineer a recovery from that recession by cutting interest rates. In Europe central banks injected liquidity and rode out what may have become as serious a recession as that witnessed in the early 1990s.
But some now think (and this includes Paul Krugman, the newly-awarded Nobel Prize winner for economics) that the Americans have been looking like the Japanese for quite a while: The Fed had a hard time getting traction. Despite repeated interest rate cuts, which eventually brought the federal funds rate down to just 1%, the unemployment rate just kept on rising; it was more than two years before the job numbers started to improve. And when a convincing recovery finally did come, it was only because Alan Greenspan had managed to replace the technology bubble with a housing bubble.
Housing bubble
Now the housing bubble has burst, leaving the financial landscape bereft of confidence, liquidity and capital resources. Even if the ongoing efforts to rescue the banking system and unfreeze the credit markets work - and while its early days yet, the initial results have been disappointing - it's hard to see housing making a comeback in the short to medium term.
In other words, there's not much Ben Bernanke can do for the economy. He can and should cut interest rates even more - but nobody expects this to do more than provide a slight economic boost.
On the other hand, there's a lot the US government can do for the economy.
It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. Similar policies will be needed in Europe and probably in Japan. The governments of the main economies can provide emergency aid to state and local governments, so that they aren't forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages and restructure the terms to help families stay in their homes.
Look after the economy
This is also the right time to engage in some serious infrastructure spending. The usual argument against public works as economic stimulus is that they take too long: By the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn't needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil.
If Barack Obama becomes president, he won't have the same knee-jerk opposition to spending. But he will face a chorus of inside-the-Beltway types telling him that he has to be responsible, that the big deficits the government will run next year if it does the right thing are unacceptable.
He should ignore that chorus. The responsible thing, right now, is to give the economy the help it needs. Now is not the time to worry about the deficit.
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