I was reading today Paul Krugman’s article, Why Weren’t Alarm Bells Ringing? He is painting a picture of how the crisis formed and secular stagnation followed. It seems that he is trying to paint a complete picture so that anyone could understand the crisis completely just from reading his post.
However, he is missing an important part of the picture. I point to a sentence…
“Even if you believe that financial excess set the stage for the slump that followed—and despite my sympathy for the secular stagnation view, I guess I mostly do—there was still no good reason why the slump had to be as terrible as it was. Containing the fallout from a financial crisis isn’t nearly as easy as Milton Friedman misled economists into believing, but it’s not impossible.”
Do you believe the bolded words? Is there really no good reason for why the slump was so terrible? Do you accept his view without question? Do we dare say that the master missed something?
Well, there is a good reason why the slump became terrible. It is important to note that fiscal and monetary policies lose effectiveness against this reason. Labor’s share of income dropped precipitously from its historic range. There are good reasons for this drop. Countries far and wide are dropping their labor share to compete globally with the likes of China and Germany. The drop in labor share has turned into a death spiral for the global economy. Effective demand is tight everywhere now. Fiscal policy fell short to reverse this drop in labor share by not focusing on job & labor income creation. Monetary policy
became ineffective lost effectiveness to counteract the drop in the liquid flow of consumer demand.
In a post yesterday about Pavlina Tcherneva, we see that the bottom 90% of incomes has progressively received less and less of the gains during recoveries for decades. Until finally, the bottom 90% is losing in this recovery. This fact has created a deeper and more sluggish recovery. Eventually it will be understood that potential output has been reduced because of labor losing economic strength.
If you add this critical aspect to the picture that Paul Krugman is painting, you get a more complete picture.