La vie en foreclose

That's right, not through pink glasses (i.e. rose). Randy Wray, Charles Whalen and Stephen Roach, all in the same page, asking for debt relief as essential for recovery, since most consumers are still de-leveraging from the housing bubble.

Both Keynes and Irving Fisher suggested that debt-deflation was at the heart of the Great Depression, and in that case debt relief for households should be at the center of the recovery. In the 1930s, the New Deal did provide a lot of debt relief for farmers, on top of trying to raise the prices of agricultural commodities (in order to help famers). Now more is needed in the housing front. The figure below shows how much the debt of the non-financial sector has fallen since the beginning of the crisis.

From the peak in 2008, it has fallen around US$ 700 billions. It's likely to continue. The problem is that consumer spending was tied to the ability to obtain credit, i.e. of getting indebted. And mortgages were central for consumers.

The end of the New Deal as we know it?

So it seems that Obama is willing to play ball with Republicans on the debt-ceiling issue.  Meaning cut Medicare and Social Security in exchange of an increase in the debt limit, increasing planned cuts for the next ten years from somewhere around two to closer to four trillion dollars.  This was reported by the Washington Post, and seems to be in accordance with, not just Obama’s politics, but of the mainstream democrats since Carter and including Clinton, who notoriously ended welfare as we knew it.

It’s incredible that Obama would cave without putting a fight (he says that the WaPo story is overhyped apparently, but suggests that Social Security should be a means tested program!).  This basically implies that the long fight that started with Reagan’s presidency to dismantle the basic achievements of the New Deal will finally succeed under a democratic presidency.  But, on the other hand, it is part of the democratic move to the right, at least on economic issues, since Carter.

The graph shows the rate of growth of median income since 1948.  The average rate of growth until 1979, before the Volcker shock, was 2.4 per cent.  Since the Reagan administration it has been 0.5 per cent.  That is the miracle of trickle down economics.  And it is because the economic performance is so poor that fiscal problems have taken place.  It is ironic that conservatives managed to sell the failure of their policies as the reason why those very same policies should be pursued.

Lucas and Intelligent Design

A friend send me Lucas' Milliman Lecture at the University of Washington (Krugman commented here).  Lucas argues that this crisis was like the depression the result of a significant monetary contraction (he believes in Real Business Cycles, RBC, but only when it is convenient apparently), and suggests that Friedman and Schwartz Great Contraction interpretation of the Depression is correct.  For him recovery was slow (in spite of unemployment falling from almost 25% to around 9% from 1933 to 1936!) because the government intervened and demonized businessmen.  This is basically the same piece of ideological propaganda that Amity Shlaes in her book The Forgotten Man (terrible book, by the way) has been pushing around.

Certain things have to be said again and again because some people keep repeating lies until they become credible.  The New Deal did work (see here)!  Unemployment did fall significantly, and when they tried fiscal adjustment in 1937 (fall in expenses associated with pensions for WWI veterans, and new taxes associated to the Social Security Act) the economy contracted.  There is a reason why everybody in the profession became a Keynesian in the 1940s; because it worked, and the war economy was the ultimate proof of it.

In Lucas' view, recovery depends on the confidence of businessmen.  The question that people that believe in what Krugman aptly calls as the Confidence Fairy have to reply is why would businessmen invest if the economy is in the dumpster, and there is no demand for their goods, let alone to create new capacity by buying machines!  And should I also add that the evidence for investment is that it follows output?!  Logic and evidence have no relation with the sort of stuff Lucas believes, and he should not be taken seriously.

I'll quote again Marriner Eccles, the chairman of the Fed during the Depression, and a Republican from Utah, on the subject of confidence.  He said:

"Confidence itself is not a cause. It is the effect of things already in motion. (...) What passed as a 'lack of confidence' crisis was really nothing more than an investor's recognition of the fact that new plant facilities were not needed at the time."

And Eccles actually knew a thing or two about running real businesses.  Put clearly, lack of confidence is the result of lack of demand.  We need more stimulus, and confidence will return.

Lucas had a poisonous effect on the profession, leading it back to the dark ages of macroeconomics.  He wants now to push the same sort of inane idiocy in the policy arena.  He suggests that the slow recovery results from Obama's European style social democratic programs!  Next thing he'll say that Obama is Kenyan.  Lucas and the New Classical Rational Expectations (and RBC) School are the intelligent design of economics.  They should have the same status in the scientific community.