A talk given by Christina Romer was very good. (Posted by Mark Thoma) She said many practical things about economic downturns. She loved to refer back to the Great Depression. The basic message was not to fear downturns, and to be careful of doing anything to prolong them. Economies will recover normally and fairly quickly with supportive policy.
She points to shocks that prolong recoveries, such as cutting back on government spending and raising interest rates too fast. But I must say that a certain shock has been left out of her presentation. That is the shock of a falling labor share which was not normal after a recession and which explains stubbornly high unemployment through weak demand. Yes, deleveraging will cut into consumer spending. Yet, a drop in labor share will also cut into consumption due to the compounded constraint on labor’s liquidity.
Christina Romer wants us to learn from the Great Depression… So let’s remember that the minimum wage was made law in 1938. Unemployment fell after that.
As far as the current crisis… Yes, the Fed should have acted with aggressive monetary policy… Yes, the government should have responded with aggressive fiscal stimulus. Yet, there is a serious social problem getting worse, which is inequality. Society will pay heavily into the future for the current policies exacerbating inequality. Political influence is more unbalanced. Ownership of capital is more unbalanced.
I would love to support continued aggressive policy to bring the economy back to full employment, but the social cost of inequality is sickening. And if stopping this disease means putting the economy back into a recession, then so be it. As it is, Christina Romer is telling us not to fear an economic correction as long as its recovery is done correctly. It is like re-breaking a bone to set it straight. If the re-breaking of a bone is not done, the bone won’t work correctly in the future. It is proper medicine. You will be better off going through the moment of extra pain. (This is a link if you want to understand the medical wisdom behind re-breaking bones.)
In hindsight, along with aggressive fiscal and monetary policy after the crisis, we should have had aggressive policy for directing liquidity to middle and lower income groups. Mrs. Romer said this too in her talk referring to helping middle income groups with their debt overhang.
My prescription is to re-break the economic bone which has not set correctly, and this time let’s be aggressive in setting straight better wages and labor share from the start.
The idea of re-breaking the economy may sound crazy to you, but the methods of medicine have a greater wisdom than what I see currently among economists. The Volcker recession was good medicine. It had a wisdom to re-break the economy to correct inflation. Current day economists seem squeamish about an economic correction, even if it was to correct mistakes.