The Obama Stagnation: What Went Wrong? Yet Again!: Tuesday Focus: May 20, 2014

Yet again? Yet again! It cannot be healthy for me to keep worrying this over and over again. But I do. The question of how we got into this Obama Stagnation–this situation in which US real GDP is 8% below its pre-2008 trend, with no signs of it ever reapproaching that trend–continues to bother me.

I continue to worry it for two big reasons:

1. It is the lowest-hanging fruit for equitable growth here in America. If you want to grow the economy in a way that shrinks income disparities, rebalancing the macroeconomy and returning to the old 1990s full-employment high-pressure economy is by far the easiest way to do the most good.

2. It is, I think, by far my greatest career analytical failure. I used to think that my greatest analytical failure was not seeing that NAFTA would generate a demand by Mexico’s wealthy for assets in the U.S. that would swamp the demand it would create by America’s corporations for factories in Mexico. Thus I did not see that NAFTA would weaken rather than strengthen the peso. But this is a bigger analytical howler. If you had asked me back in 2007 what the chances were that we would be here today, I would have given you all probably 100-to-1, and certainly 20-to-1 against–and I would have been willing to bet a substantial portion of my net worth on that position. And I would have been taken to the cleaners.

I think it is important for me not to make the same analytical mistakes. I think it important for me not to get things so wrong again in the same way. And it is important for us–the economic policymaking and policy-advising community–to never again make as hideous policy blunders as we have made since 2007, for these blunders have wedged the North Atlantic economy in its current state.

Now it is very important to maintain perspective.

I do recognize that Obama, Geithner, and company have done very well relative to other policymakers in the North Atlantic and North Pacific. Graded on a curve, they get at least a B+: we would be much worse off today had we here in America swapped policymakers with those of Britain, of the European Union, or of Japan.

Nevertheless…

This morning’s Lesson is from Jared Bernstein:

Jared Bernstein: Diagnoses and Prescriptions: The Great Recession: “Tim Geithner… defends the… reflat[ion of] credit markets…

…Mian and Sufi… argues… Treasury got it wrong… not recognizing… [that] debt burdens were restricting growth… [not] writ[ing] off more debt…. Dean Baker has long argued the problem was not just the debt overhang but the wealth effect’s sharp shift into reverse when the housing bubble burst…. What I think…. You have to do everything you can… reflate the credit system through… liquidity [injections]… as well as Mian/Sufi-style principal reductions and cramdowns….

The administration did a lot of the former and little (not none) of the latter. Why not? From where I sat, and I didn’t see everything from my seat for sure, it was less about protecting creditors per se than the belief that breaking contracts was an interventionist step too far (though the fact that this principal was less active in the auto-bailout suggests a protection that extended more to white than blue collar industry)….

Let’s keep it real: the problem was not only that we didn’t do all of the above. It’s that even when we did the right things, we didn’t stick with them long enough. The important thing now is to try to learn from our mistakes, and I for one am thankful to all of these authors for continuing to plumb these deep waters.

Why, even at the end of 2008, would I have given 20-to-1 or 100-to-1 odds against us being as wedged as we now are? Because I did not believe that there was a deflation-austerity lobby: it seemed to me that, after World War I, nobody had a portfolio so heavily weighted toward nominal bonds that they benefited financially from near-universal bankruptcy. Therefore, I thought, the fundamental interests of those who could pressure the political system would lead to successful reflation back to full employment and potential output.

And only one of three things had to go right. In order to wedge us where we are now:

• Fiscal authorities in reserve-currency economies had to fail to grasp the bull by the horns and borrow and spend to reflate the economy…
• Monetary authorities had to fail to promise low-enough nominal interest rates and high-enough inflation rates to push the real market rate of interest down to the Wicksellian natural rate to reflate the economy…
• Banking regulatory authorities had to fail to do their financial-crisis job of turning underwater debt into equity and recapitalize the banking system and so push risk spreads down and credit availability up to reflate the economy…

And I thought these were roughly independent: that each one of these three had perhaps a one third can of failing to do their job. Cube 0.3 and you get only a 2.7% chance of failure: the bet that by 2014 there would have been successful reflation look AAA to me…

I guess it was my application of the Gaussian Copula to economic policy that led me astray…