Monday, August 10, 2009

The Kroog Versus Worst-Case Scenarios

Paul Krugman has a very interesting theory this morning in his column: since we've averted the worst-case scenario on the economy (so far), it's time to admit how America did it: Big Government.
So what saved us from a full replay of the Great Depression? The answer, almost surely, lies in the very different role played by government.

Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done: unlike the private sector, the federal government hasn’t slashed spending as its income has fallen. (State and local governments are a different story.) Tax receipts are way down, but Social Security checks are still going out; Medicare is still covering hospital bills; federal employees, from judges to park rangers to soldiers, are still being paid.

All of this has helped support the economy in its time of need, in a way that didn’t happen back in 1930, when federal spending was a much smaller percentage of G.D.P. And yes, this means that budget deficits — which are a bad thing in normal times — are actually a good thing right now.

In addition to having this “automatic” stabilizing effect, the government has stepped in to rescue the financial sector. You can argue (and I would) that the bailouts of financial firms could and should have been handled better, that taxpayers have paid too much and received too little. Yet it’s possible to be dissatisfied, even angry, about the way the financial bailouts have worked while acknowledging that without these bailouts things would have been much worse.

The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed. And that’s another reason we’re not living through Great Depression II.

Last and probably least, but by no means trivial, have been the deliberate efforts of the government to pump up the economy. From the beginning, I argued that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, was too small. Nonetheless, reasonable estimates suggest that around a million more Americans are working now than would have been employed without that plan — a number that will grow over time — and that the stimulus has played a significant role in pulling the economy out of its free fall.

All in all, then, the government has played a crucial stabilizing role in this economic crisis. Ronald Reagan was wrong: sometimes the private sector is the problem, and government is the solution.
My argument is that the stimulus package has yet to be accompanied by real regulatory safeguards that will prevent the next crisis from happening. But I absolutely agree with Kroog that the stimulus package has prevented a worst-case scenario, at least for now.

My fear is that the lack of regulation reform makes that worst-case model likely down the road, and that's a more important component of government than the spending in the long run (short run of course, it's the money, stupid.) Whether or not you want to see a larger package or not, long-term, we do need fundamental reform of the banking system. That reform is not here yet, and it's looking increasingly likely that it will not be happening as the public appetite for reform the banksters is running into the conservative cry that government is the enemy.

Conservatives may be pushing the evil government theory to fight Obamacare, but the fact that the massive anti-government push is tamping down the desire to regulate the big banks as well is no coincidence, either.

2 comments:

Paul W. said...

Zandar, would you mind doing a post pulling together a few articles of what is in the works for future regulations? I have read a few with positive signs: distancing ratings agencies from issuers of CDS, increased capital cushions for banks (done right, we won't have to bail out insolvent banks again), having a central clearing house for the majority of CDS' to bring more of the dark market into the light, more teeth for regulators of finance, a mandate to watch systemic risk.

From what I have seen, what isn't included is: changing the incentive structure of investment banks (capping bonus' is not the way to do it imo), breaking up banks that are too big to fail, and I'm sure there is more. I think it is something to definitely keep an eye on because as you and others have pointed out, we may be rising from the ashes of the current downturn but we need to institute rules that divert us away from the next.

Zandar said...

The main thing Paul is that main avenue of overhaul is eliminating several smaller agencies (keeping from banks/insurance/investment congolomerates from shopping for the best regulatory deal) which is good, and then giving all that oversight power to the Fed (which has no oversight over itself) which is bad.

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