Recessions can occur for a variety of reasons. For example, oil price shocks, stock market crashes, housing bubbles, monetary shocks, and productivity shocks can all lead to economic downturns. However, curiously, while the effects of a recession differ depending upon the cause, the response of policy - fiscal policy in particular - tends to be the same. This is undesirable, since a policy tailored to the specific type of recession would result in a speedier recovery. Monetary policy is better on this score, particularly nontraditional policy, but even this could be improved along these lines.
One way to distinguish recessions is through differences in their effects on balance sheets, in particular those of households and banks. For households, the collapse of a housing bubble, which also tends to cause a stock market crash, results in a decline in home equity as well as the loss of retirement and education savings. When combined with the loss of jobs due to the recession, and the fact the debts do not decline with the fall in asset values, the effect on balance sheets can be devastating - much larger than, say, the balance sheet impact of an oil price shock. Households have no choice but to set aside part of their income to both rebuild the asset side of the balance sheet and to pay down their debts.This is one of the main reasons why recovery from these 'balance sheet recessions' is notoriously slow. As households rebuild their balance sheets, resources are directed away from consumption, and the reduction in aggregate demand is a drag on the economy. It takes a long time for households to recover what is lost, and the recovery will be slow so long as this rebuilding process continues. Fiscal policy attempts to restore the lost aggregate demand, and that is important, but it does very little to directly address the household balance sheet issue.
There's no mystery about balance sheet recessions. Japan's experience in the 1990s should have been all the experience the world ever needed to learn how they work--and how not to respond to them. And yet, discussion of them has generally failed to take hold, even though they should obviously be dominating our thinking. From a fiscal policy point of view, Thoma's article is not just common sense, it ought to be boringly obvious. But it's not, because our political economy discourse simply won't make room for it. Instead, it's driven by zombie lies--as Paul Krugman has been writing about quite a bit in recent days. (More on that later today).
The fact that sensible voices like Thoma's are so marginalized is something we need to take much more seriously--and that's where I want to take this diary, by way of a truly remarkable piece by David Cay Johnston, 'Reasons, Rule and Riots: Our Societal Panic'. Johnston begins with a clear-eyed look at th craziness of the GOP-Obama tax deal, but then steps back to make a rare, but obvious observation: that this craziness is but a symptom of a much deeper cognitive derangement, which we can only understand by looking at other such traumatic examples from history, such as the lawless, chaotic industrialization of the Guilded Age, or the two centuries of chaos that followed the invention of coinage in ancient Greece. Here's how his piece begins:
On the surface, what's going on with tax policy in Washington right now seems crazy. A Democratic president whose enemies call him a socialist makes a deal with Republicans that sells out both his party and the very tax promises that won him the election, while Republicans leaders who say that debt is our overwhelming domestic problem insist on borrowing tens of billions of dollars to give tax savings to the richest among us. The polls, at the same time, show the public overwhelmingly favors ending tax cuts for high earners.What we are witnessing, however, is much more profound than political, economic, or fiscal insanity. And it goes much deeper than disputes over whether extending temporary tax cuts for two years and long-term jobless benefits for 13 months is politically or economically smart. Those are mere manifestations of a much more pervasive problem.
America is in the grip of a full-blown societal panic. Crazy, irrational, contradictory ideas about tax policy are just the most obvious symptom.
Societal panics occur when the expectations and rules everyone has been accustomed to living under no longer work. They occur when some new force changes the rules of the game -- a force that may be easy to identify or invisible, but whose effects are far-reaching and unstoppable....
Because no one knows quite what to do when the old ways stop working, panic sets in, replacing reason. Crazy responses spread until an idea or a leader emerges, a new way to make sense of the change. The new leader is often the one who persuades people that it is better to live by new rules.
Humans have experienced societal panics time and time again. Sometimes they end in tragedy, sometimes in triumph. And those unexpected accidents of history often play a huge role in the outcome.
Next Johnston introduces the two historical panics I mentioned:
Consider what happened to the Greeks 2,700 years ago. Greek settlers in Lydia, what is now the Mediterranean coast of Turkey, found a mine rich with electrum, a naturally occurring alloy of gold and silver. This find resulted in the invention of coinage, an invention so revolutionary that it launched the ancient Greeks into a societal panic that lasted two centuries, but at its end gave us two of the most powerful, intertwined, and enduring principles of Western Civilization -- the moral basis for progressive taxation and democracy.America was in the grip of a societal panic from the end of the Civil War until 1893, an era historians call the Gilded Age, but that could just as easily be called the Agrarian Death or the Industrial Triumph as America the land of yeoman farmers became America the land of industrial might. It was an era of turmoil and conflict -- gilded mansion ceilings and a famous speech about oppressive debt and a gold cross; the invention of the electric light and violent night-time attacks on workers seeking more pay; and our first encounter with a politician who lost the popular vote but became president anyway.
And then he looks to our own:
Our current societal panic began almost four decades ago, when the economic glow created by emerging from World War II with half the world's industrial capacity wore off and President Nixon went to Beijing, opening the door to the transfer of that manufacturing capacity to China.The long-term effects of this, and the faux 'free trade' policies adopted at the behest of our financier class, took time to affect society, just as the invention of coinage did not instantly disrupt ancient Greek social and commercial relations.
Our panic turned into wildly unthinking behavior at the end of the last century, with taxes as the first sign that reason was giving way to belief, that dogma was trumping empirical evidence.
But while the symptoms we see are crazy tax policies, crazy borrowing, and neglect of the commonwealth property and policies that are the foundation for private wealth creation, our panic is about something much deeper.
Our societal panic is about what we as a nation fear almost as much as death itself -- the end of American abundance, the death of the idea that each generation would do better than the last, the end of the notion that everyone who works hard and plays by the rules will at least prosper in the sense of having a roof over their heads and enough to eat. Our societal panic is about a new world of mind-numbing complexity where speculation with algorithms and borrowed money pays more in a day than thoughtful investment may return in a lifetime, where jobs pay less tomorrow than yesterday, and where loyalty is something we associate with frequent flier programs rather than careers.
We've talked somewhat, recently, about the differences and similarities between Bill Clinton and Barack Obama. Here is certainly one of them: Clinton spoke passionately and at great length about a fair shake for "everyone who works hard and plays by the rules". In the end, he did not grasp the most fundamental forces at work, and under the tutelage of Robert Rubin, his deregulatory policies continued the process of making things even worse, but he at least had some sense of what the problem was as people experienced it. He really did feel their pain, he didn't just intellectualize it.
Obama, on the other hand, appears pathetically small in light of the broad picture Johnston paints, if only because he seemed to promise to be so big. Indeed, his description of the Greek's two-centuries-long panic, and how Solon eventually ended it reminds us of the extraordinary hope that people had in Obama's capacity to help us focus on the deeper problems bedeviling us:
It took the Greeks two centuries to work through the issues that began in Lydia, what we now call the Age of Tyrants. Their panic eventually produced the plays of Aristophanes and in time gave birth to two of the greatest ideas of Western Civilization, ideas intertwined to this day -- the moral basis of progressive taxation and the various forms of self-rule we call democracy.But before the classical age in Greece there was draconian law, named for the dictator Draco, who decreed death for all crimes because, he reportedly said, it was the appropriate sentence for petty theft and he could not think of a harsher punishment for worse offenses.
The Greeks endured these harsh laws for four decades, a reminder of how long people will endure harsh and unjust policies. Then came Solon, who repealed Draco's harsh laws, except for death as punishment for murder. Solon also forgave all debts, which enriched those who had borrowed heavily at the expense of the lenders and, for a time, made credit hard to get for poor farmers.
Eventually the crisis created by coinage helped the Greeks work through the idea of what freedom meant, how laws could define conduct, and how economic power was separate from political power. This last insight resulted in the Greeks' reasoning that it was only because of Athens -- its laws, its courts, its military -- that one could legitimately acquire riches and have them protected, for in his natural state man was in a jungle, a war of one against all in which riches came by luck or plunder and could be taken away by brute force.
That insight resulted in the first progressive taxation. The moral basis for this was the principle that the greater the wealth Athens made possible, the greater the burden the wealthy must bear to sustain Athens, which in turn protected that wealth through laws and its military. Intertwined with that was the birth of the ancient world's first recorded example of self-rule through one-man, one-vote for Athenian citizens.
Societal panics, the ancient Athenians showed us, can have remarkably positive outcomes, although getting there can take a long time when much damage is done to society.
This is a very compelling, succinctly-told story of how enduring wisdom came out of suffering. And it was many people's sincere belief that Obama would be a Solon-like figure. This was not just the vague hope of millions who supported him. It was also certainly the belief of the Nobel Prize committee that gave him the prize just for getting elected. And yet, instead of that Obama has emerged as just another figure tossed about on surface tempests of a flood he can't come close to comprehending.
Which brings us back to Thoma's piece.
In contrast to the failure to help out households and their balance sheets, he says:
The same cannot be said about bank balance sheets. The effect on bank balance sheets also varies with the type of recession, and a financial collapse brought about by bad loans is particularly severe. The present recession is an example of this, and policy has done a good job of preventing even worse problems from developing by rebuilding financial sector balance sheets through the bank bailout and other means.But household balance sheets have not received as much attention. We could have helped households rebuild their balance sheets, and this would have helped banks by lowering the default rate on loans. Instead, we left households to mostly solve their problems on their own, and then helped banks when households could not repay what they owed.
When a balance sheet recession hits, one of the keys to a quick recovery is to use the federal government's balance sheet as a means of offsetting the deterioration in the private sector's financial position. But we shouldn't just focus on banks. Household balance sheet problems are every bit as severe, and in total every bit as systemically important as the balance sheet problems of banks. We'll recover faster from balance sheet recessions if we pay attention to all private sector balance sheets instead of focusing mainly on the problems of banks.
This is simple common sense, but Obama ignored it. He did so in part because he bought into the failed conservative worldview, pointing out that he didn't want to help homeowners who had "acted irresponsibly" as Wall Street's defenders like to say. This is a reflection on Obama's profound superficialiaty, his utter lack of Solon's gravitas--much less that of FDR or LBJ. In the midst of such a profound and long-lasting social panic, one cannot right things by trying to bring together existing factions, even if one does it much more thoughtfully and responsibly than Obama has done.
One must, instead, think anew--as Lincoln famously declared. One must see deeply into the underlying sources of panic and confusion, and confront them in a new way that still draws strength, inspiration, and moral insight from the wisdom of the ages that has temporarily been eclipsed. This is what people voted for when they voted for Obama. And this is what has been utterly, totally missing in his presidency.
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