The Coming "Conservative" Depression

Economist Paul Krugman warned in early 2009 that if the administration failed to stimulate the economy appropriately and resorted to more politically acceptable half measures instead that we would quickly find ourselves in a depression as fiscal policy became politically impotent. That warning proved prescient.

Tea Party protests across the nation (the photo at right is from Chicago) reflect genuine outrage that the government spent so much with insufficient benefits to ordinary citizens or the economy in general. Nor can the Tea Party be dismissed as a small group of extremists on this issue as most informed analyses of the 2010 mid-term elections now project a decisive GOP victory complete with a transfer of power in the House. Amazingly, one poll found that only 6% of Americans feel the stimulus package helped reduce unemployment.

Krugman is hardly alone among top economists that feel the economy is desperately in need of more stimulus. Another Noble laureate, Joseph Stiglitz, has repeatedly called for more stimulus spending since at least 2009. More recently, Noble economist Robert Solow published an article explaining the need for a second stimulus. The problem is that going forward the original stimulus will expire in the second half of 2010 and in combination with the cutbacks at the state level government spending will shift from stimulating our very weak economy to creating substantial headwinds that will slow growth at the least and tip us into depression at worst. The states are acting like fifty Herbert Hoovers in terms of cutting expenditures in the face of a severe downturn. In fact, government investment and consumption at all levels has actually stagnated or contracted as a percentage of GDP since the onset of the financial crisis in 2008. Most of the increases in government spending have not been due to any massive public works program (a relatively small part of the stimulus package) but rather automatic stabilizers such as unemployment insurance.

Those automatic stabilizers work wonders. For example, in Germany, automatic stabilizers have led to massive increases in government spending that exceed the increases in government spending in the U.S.--and led Germany into positive GDP to the tune of 9% growth. The United States however, suffers from built-in automatic destabilizers--the fifty states with balanced budget mandates and a body politic schooled in macroeconomic mythology.

If so, 2010 and 2011 are likely to see the "conservative" depression--with only tax cuts on the agenda that will further balloon the deficit while offering very little actual stimulus in the present debt-deleveraging context.

The upshot of this "inconceivably ugly" reality is that the economy is almost certain to face severe challenges this year and next with little or no prospect of either further monetary or fiscal support. The elections are likely to result in fiscal gridlock and our broken banking system renders monetary policy impotent.

This entire episode of fiscal policy impotence would have been a great historical example of why fiscal policy requires legal restructuring, including a shift to a depoliticized expert agency, to add to my article, Fear and Social Capitalism.