Did big economies get it wrong after the crash?

Nothing prevents the US economy from being run in a way that spreads the wealth except the greed of the elite, writes Joseph Stiglitz.

Did big economies get it wrong after the crash?

Yes, and the reasons are political myopia and selfishness

Nothing prevents the US economy from being run in a way that spreads the wealth except the greed of the elite, writes Joseph Stiglitz.

IN the aftermath of the 2008 financial crisis, some economists argued that the United States, and perhaps the global economy, was suffering from “secular stagnation”, an idea first conceived in the aftermath of the Great Depression of the 1930s.

Economies had always recovered from downturns. But the Great Depression had lasted an unprecedented length of time. Many believed the economy recovered only because of government spending on the Second World War, and many feared that with the end of the war the economy would return to its doldrums.

Something, it was believed, had happened, such that even with low or zero interest rates, the economy would languish. For reasons now well understood, these dire predictions fortunately turned out to be wrong.

Those responsible for managing the 2008 recovery (the same individuals bearing culpability for the under-regulation of the economy in its pre-crisis days, to whom then US president Barack Obama inexplicably turned to fix what they had helped break) found the idea of secular stagnation attractive, because it explained their failures to achieve a quick, robust recovery.

So, as the economy languished, the idea was revived: Don’t blame us, its promoters implied, we’re doing what we can.

The events of the past year have put the lie to this idea, which never seemed very plausible. The sudden increase in the US deficit, from 3% to 6% of GDP, owing to a poorly designed, regressive tax bill and a bipartisan expenditure increase, has boosted growth to 4% and brought unemployment down to an 18-year low.

These measures may be ill-conceived, but they show that, with enough fiscal support, full employment can be attained, even as interest rates rise well above zero.

The Obama administration made a crucial mistake in 2009, in not pursuing a larger, longer, better-structured, and more flexible fiscal stimulus.

Had it done so, the US economy’s rebound would have been stronger, and there would have been no talk of secular stagnation. As it was, only those in the top 1% saw their incomes grow during the first three years of the so-called recovery.

Some of us warned, at the time, that the downturn was likely to be deep and long, and that what was needed was stronger and different from what Obama proposed.

I suspect that the main obstacle was the belief that the economy had just experienced a little bump, from which it would quickly recover.

Put the banks in the hospital, give them loving care (in other words, hold none of the bankers accountable, nor even scold them, but, rather, boost their morale by inviting them to consult on the way forward), and, most important, shower them with money, and soon all would be well.

But the economy’s travails were deeper than this diagnosis suggested. The fallout from the financial crisis was more severe, and massive redistribution of income and wealth toward the top had weakened aggregate demand.

The economy was experiencing a transition from manufacturing to services, and market economies don’t manage such transitions well on their own.

What was needed was more than a massive bank bailout. The US needed a fundamental reform of its financial system.

The 2010 Dodd-Frank legislation went some way, though not far enough, in preventing banks from doing harm to the rest of us; but it did little to ensure that the banks actually do what they are supposed to do, focusing more, for example, on lending to small and medium-size enterprises.

More government spending was necessary but so too were more active redistribution and pre-distribution programmes — addressing the weakening of workers’ bargaining power, the agglomeration of market power by large corporations, and corporate and financial abuses.

Likewise, active labour-market and industrial policies might have helped those areas suffering from the consequences of deindustrialisation.

Instead, policymakers failed to do enough even to prevent poor households from losing their homes. The political consequences of these economic failures were predictable and predicted: there was a risk that those who were so badly treated would turn to a demagogue.

No-one could have predicted that the US would get one as bad as Donald Trump: A racist misogynist bent on destroying the rule of law, both at home and abroad, and discrediting America’s truth-telling and assessing institutions, including the media.

A fiscal stimulus as large as that of December 2017 and January 2018 (and which the economy didn’t really need at the time) would have been all the more powerful a decade earlier, when unemployment was so high.

The weak recovery was thus not the result of “secular stagnation”; the problem was inadequate government policies.

Here, a central question arises:

Will growth rates in coming years be as strong as they were in the past? That, of course, depends on the pace of technological change.

Investments in research and development, especially in basic research, are an important determinant, though with long lags; cutbacks proposed by the Trump administration do not bode well.

But even then, there is a lot of uncertainty. Growth rates per capita have varied greatly over the past 50 years, from between 2% and 3% a year, in the decade(s) after the Second World War, to 0.7%, in the last decade.

But perhaps there’s been too much growth fetishism — especially when we think of the environmental costs, and even more so if that growth fails to bring much benefit to the vast majority of citizens.

There are many lessons to be learned, as we reflect on the 2008 crisis, but the most important is that the challenge was — and remains — political, not economic: there is nothing that inherently prevents our economy from being run in a way that ensures full employment and shared prosperity.

Secular stagnation was just an excuse for flawed economic policies. Unless, and until, the selfishness and myopia that define our politics — especially in the US, under Trump and his Republican enablers — are overcome, an economy that serves the many, rather than the few, will remain an impossible dream. Even if GDP increases, the incomes of the majority of citizens will stagnate.

Joseph E Stiglitz is the winner of the 2001 Nobel Memorial Prize in economic sciences. His most recent book is Globalisation and its Discontents Revisited: Anti-Globalisation in the Era of Trump.

No, secular stagnation was a real fear after 2008

Left to its own devices, the economy might not have bounced back, and so fiscal expansion was necessary, says Lawrence H Summers.

Joseph Stiglitz has dismissed the relevance of secular stagnation to the American economy, and attacked (without naming me) my work in the administrations of former US presidents, Bill Clinton and Barack Obama.

This is not the first time that I find Stiglitz’s policy commentary as weak as his academic, theoretical work is strong.

Stiglitz echoes conservatives like John Taylor, in suggesting that secular stagnation was a fatalistic doctrine invented to provide an excuse for poor economic performance during the Obama years.

This is simply not right. The theory of secular stagnation, as advanced by Alvin Hansen and echoed by me, holds that, left to its own devices, the private economy may not find its way back to full employment following a sharp contraction, which makes public policy essential. I think this is what Stiglitz believes, so I don’t understand his attacks.

In all of my accounts of secular stagnation, I stressed that it was an argument not for any kind of fatalism, but rather for policies to promote demand, especially through fiscal expansion.

In 2012, Brad DeLong and I argued that fiscal expansion would likely pay for itself. I also highlighted the role of rising inequality in increasing saving and the role of structural changes toward the demassification of the economy in reducing demand.

What about the policy record? Stiglitz condemns the Obama administration’s failure to implement a larger fiscal stimulus policy and suggests that this reflects a failure of economic understanding.

He was a signatory to a November 19, 2008 letter, also signed by noted progressives, James K Galbraith, Dean Baker, and Larry Mishel, calling for a stimulus of $300bn-$400bn — less than half of what the Obama administration proposed. So matters were less clear in prospect than in retrospect.

We on the Obama economic team believed that a stimulus of $800bn — and likely more — was desirable, given the gravity of the economic situation.

We were told by those on the new president’s political team to generate as much validation as possible for a large stimulus, because big numbers approaching $1tn would generate “sticker shock” in the political system.

So, we worked to encourage a variety of economists, including Stiglitz, to offer larger estimates of what was appropriate, as reflected in the briefing memo I prepared for Obama.

Despite the incoming president’s popularity and an all-out political effort, the Recovery Act passed by the thinnest of margins.

I cannot see the basis for the argument that a substantially larger fiscal stimulus was feasible. And the effort to seek a much larger one would have meant more delay, when the economy was collapsing, and could have led to the defeat of fiscal expansion.

I think Obama made the right choices in approaching fiscal stimulus, but it is highly regrettable that, after the initial Recovery Act, the US Congress refused to support a variety of Obama’s proposals for infrastructure and targeted tax credits.

Unrelated to secular stagnation, Stiglitz takes a swipe at me by saying that Obama turned to “the same individuals bearing culpability for the under-regulation of the economy in its pre-crisis days” and expected them “to fix what they had helped break.”

I find this a bit rich. Under the auspices of the government-sponsored enterprise (GSE) Fannie Mae, Stiglitz published a paper in 2002, arguing that the chance that the mortgage lender’s capital would be depleted was less than one in 500,000, and in 2009 he called for nationalisation of the US banking system.

So I would expect Stiglitz to be well aware that hindsight is clearer than foresight.

What about the Clinton administration’s record on financial regulation? With hindsight, it would have been better if we had foreseen the need for legislation like the 2010 Dodd-Frank reforms and had a way to enact it with a Republican-controlled Congress.

And certainly we did not foresee the financial crisis that came eight years after we left office. Nor did we anticipate the ways in which credit default swaps would mushroom after 2000.

We did, however, advocate for GSE reform and for measures to rein in predatory lending, which, if enacted by Congress, would have done much to forestall the accumulation of risks before 2008.

I have not seen a convincing causal argument linking the repeal of the Glass-Steagall Act and the financial crisis. The observation that most of the institutions involved — Bear Stearns, Lehman Brothers, Fannie Mae, the GSE Freddie Mac, AIG, WaMu, and Wachovia — were not covered by Glass-Steagall calls into question its centrality.

Yes, Citi and Bank of America were centrally involved, but the activities that generated major losses were fully permissible under Glass-Steagall.

And, in important respects, the repeal of Glass-Steagall actually enabled the resolution of the crisis, by permitting the merger of Bear and JPMorgan Chase and by allowing the US Federal Reserve to open its discount window for Morgan Stanley and Goldman, when they otherwise could have been sources of systemic risk.

The other principal attack on the Clinton administration’s record targets the deregulation of derivatives in 2000. With the benefit of hindsight, I wish we had not supported this legislation.

But, given the extreme deregulatory approach of former US president George W Bush’s administration, it defies belief to suggest that it would have created major new rules regarding derivatives, but for the 2000 act; so I am not sure how consequential our decisions were.

We pursued the 2000 legislation not because we wanted to deregulate for its own sake, but, rather, to remove what the career lawyers at the US Treasury, the Fed, and the Securities and Exchange Commission saw as systemic risk arising from legal uncertainty surrounding derivatives contracts.

More important than litigating the past is thinking about the future. Even if we disagree about past political judgements and about the use of the term “secular stagnation”, I am glad that an eminent theorist, like Stiglitz, agrees with what I intended to emphasise in resurrecting that theory:

We cannot rely on interest-rate policies to ensure full employment.

We must think hard about fiscal policies and structural measures to support sustained and adequate aggregate demand.

Lawrence H Summers was US secretary of the treasury (1999-2001) and is a university professor at Harvard.

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