Christina Romer, the chair of President Obama's Council of Economic Advisers, yesterday presented lessons from the Great Depression for economic recovery in 2009 at the Brookings Institution in Washington, D.C.
Her lessons serve as the basis for the Obama Administration's reaction to the credit crisis and their plans to encourage a recovery. They are well-considered, however in some cases, critically flawed.
I will respond directly to some of the sections that caught my attention the most.
This similarity of causes between the Depression and today’s recession means that President Obama begins his presidency and his drive for recovery with many of the same challenges that Franklin Roosevelt faced in 1933.
This is certainly true, and the Administration is clearly acting to prevent another Depression. By attacking the credit crisis with enormous "shock and awe" tactics and spending, the Administration hopes to cut off the crisis before it spirals downward any further. However, as I have mentioned before, spending trillions of dollars alone will not get us out of this mess.
Of course, Roosevelt's New Deal did eventually work, after a decade of misery and a World War.
As for the uses of fiscal policy, she is correct in asserting that fiscal policy did not work to solve the Great Depression:
My argument paralleled E. Cary Brown’s famous conclusion that in the Great Depression, fiscal policy failed to generate recovery “not because it does not work, but because it was not tried.
That the Obama Administration is attempting to use fiscal policy to further economic recovery is noble. However, instead of stimulative tax cuts, they are taking the opposite course and raising taxes, a decision that will most likely be questioned if the recovery takes more time than they anticipate (which is not an unlikely scenario).
On the other side of the equation, the Administration certainly is spending enough. The emergency spending that Roosevelt did was precedent-breaking—balanced budgets had certainly been the norm up to that point. But, it was quite small. The deficit rose by about one and a half percent of GDP in 1934....The American Recovery and Reinvestment Act, passed less than thirty days after the Inauguration, is simply the biggest and boldest countercyclical fiscal action in history. The nearly $800 billion fiscal stimulus is roughly equally divided between tax cuts, direct government investment spending, and aid to the states and people directly hurt by the recession....The fiscal stimulus package was designed to create jobs quickly. But answer me this: how does giving hundreds of millions of dollars to Amtrak and the Smithsonian create jobs? How were they "directly hurt by the recession?"
Of course, now that the tap has been opened, everyone wants more money from the government. Romer warns of another lesson from the Depression: beware of cutting back on stimulus too soon (bold text hers).
I sincerely hope that she doesn't expect the government to pony up trillions of dollars per year in stimulus for the next few years. Because, quite frankly, we don't have the money. Anything we spend, we have to raise in taxes and loans. Let me make this clear: raising taxes does not get you out of a recession. And increasing demand for funds, all else equal, means higher interest rates. A mini-lesson in economics: when the cost of borrowing goes up for the US government, the cost of borrowing goes up for everyone.
Romer is correct in her assessment of the plan to stablize our banking system.
The Financial Stabilization Plan, which involves evaluating the capital needs of financial institutions, as well as crucial programs to directly increase lending, is central to putting the financial system back to work for American industry and households.
As a panel of CMC professors pointed out, the number one issue the government has to deal with to get out of this crisis is stabilizing and expanding the banks' lending capacities. If we cannot do that, then all other stimulatory measures will not flow through the financial system.
Of course, there's Romer's final lesson from the 1930s:
A key feature of the Great Depression is that it did eventually end.
Personally, I'd prefer to see this recession end sooner rather than later. As Romer makes clear, immediate action is necessary. However, if by ending the recession with imprudent actions now, we force ourselves to pay unforeseen consequences in the future, her response may not be a solution at all.
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