Paul Krugman: A Permanent Slump?:
Spend any time around monetary officials and one word you’ll hear a lot is “normalization.” Most though not all such officials accept that now is no time to be tightfisted…. Still, the men in dark suits look forward eagerly to the day when they can go back to their usual job, snatching away the punch bowl whenever the party gets going…. But what if the world we’ve been living in for the past five years is the new normal… depression-like conditions are on track to persist, not for another year or two, but for decades? You might imagine that speculations along these lines are the province of a radical fringe. And they are indeed radical; but fringe, not so much…. The case for… a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between was made forcefully recently… [by] none other than Larry Summers…. And if Mr. Summers is right, everything respectable people have been saying about economic policy is wrong, and will keep being wrong for a long time….
Mr. Summers went on to draw a remarkable moral: We have, he suggested, an economy whose normal condition is one of inadequate demand–of at least mild depression–and which only gets anywhere close to full employment when it is being buoyed by bubbles.
If our economy has a persistent tendency toward depression, we’re going to be living under the looking-glass rules of depression economics–in which virtue is vice and prudence is folly, in which attempts to save more (including attempts to reduce budget deficits) make everyone worse off–for a long time. I know that many people just hate this kind of talk. It offends their sense of rightness…. Economics is supposed to be about making hard choices (at other people’s expense, naturally)…. But as Mr. Summers said, the crisis “is not over until it is over”–and economic reality is what it is. And what that reality appears to be right now is one in which depression rules will apply for a very long time.
As I see it, the possibility that we are entering a new and very different “normal” from what we thought we were in and were used to from 1950-2007–one in which the short run in which Say’s Law does not hold lasts not for two or three years but for twenty, in which depressions are falls below rather than fluctuations around trend, in which trend is in its turn profoundly influenced and substantially depressed by cyclical output gaps, and in which high inflation and explosive government debt are simply not a problem in the North Atlantic–rests on the coincidence of five market and policy failures:
- Market Failure #1: The close tie of worker morale to the absence of nominal wage cuts, so that a persistent excess supply of labor does not register on the market via declines in nominal wages.
- Market Failure #2: The failure of financial markets to mobilize the collective risk-bearing capacity of society to any appreciable extent, and the consequent enormous spread between the real expected returns on the safe debt of sovereigns with exorbitant privilege and the real expected returns on investments to build the capital stock and to build organizations.
- Market Failure #3: The inability of financial intermediaries to find effective ways of hedging or diversifying entrepreneurial risk, and thus financing risky investments from funds drawn ultimately from safety-loving savers.
- Government Failure #1: The failure of the government to act as employer or last resort, and thus find useful things for potential workers to do when the market fails to find them jobs.
- Government Failure #2: The failure of the government to act as investor of last resort, and thus match aggregate demand to potential output supply by finding ways to spend its money investment in machines, buildings, people, and ideas when the private sector is unable to deliver enough investment demand to rebalance the macroeconomy.
- Government Failure #3: The failure of the government to act as risk-bearer of last resort, and thus drive the spread between risky and safe savings vehicles low enough for the market to rebalance the market economy.
- Government Failure #4: The failure of the government to find a way to depress the real return on savings for those who value safety above all far enough below zero for the risky real return required to fund entrepreneurial projects to find its proper level.
We need all seven of these failures to hit the economy at once and to remain macroeconomically-significant market failures in order to wedge the North Atlantic economy for a generation. Yet right now we are well on the way to doing so.
The fact that this happened to Japan a generation ago ought to have been a warning to us. But we–or I, at least, dismissed Japan as not relevant to the North Atlantic: too different a society, with too many institutional and political differences to be relevant to us. But now we fear de te fabula narratur…