Wednesday, January 14, 2009

Why We Are in a Depression

Tyler Cowen:

1. We have zombie banks.

2. There is considerable regulatory uncertainty in banking and finance.

3. There is a negative wealth effect from lower home and asset prices.

4. There is a big sectoral shift out of real estate, luxury goods, and debt-financed consumption.

5. Some of the automakers are finally meeting their end, or would meet their end without government aid.

6. Fear and uncertainty are high, in part because they should be high and in part because Bush and Paulson spooked everyone.

7. International factors are strongly negative.

8. There is a decline in aggregate demand, resulting from some mix of 1-7.

I have two simple points, First, a large fiscal stimulus addresses factor #8 but fares poorly in alleviating the other problems. Of course it may give a band-aid for #5 or #6 and you can tell other stories but we are in a multi-factor depression.

Second, forecasting will prove very difficult. These factors interacted with each other in a unique manner on the way down and they may well interact in an unpredictable manner on the way back up, whenever that comes. Just for a start, who has a good model of #1, #2, or #6? Right now we're seeing a lot of good faith efforts to develop forecasts, but I say don't believe any of them, whether they support your point of view or not.



thinking said...

That's the problem...there is no textbook solution...we are in uncharted waters.

There are no guarantees no matter what actions are taken and people have to live with that uncertainty.

thinking said...

I should add that in a very generalistic, oversimplified view, the root cause of the problem is that we had created an economy based on consumption and borrowing as the drivers of growth.

The economic growth of the last few years wasn't based on new technologies, or manufacturing, or increasing exports, or increasing savings...all the signs of a healthy national economic expansion.

It was based on borrow and spend...borrow and spend. In essence, we had a phony economic expansion. The role models and heroes were people who lived lavish lifestyles and esp. those who lived in large conspicuous homes.

I now have a humorous theory: never trust an economy where a guy like Donald Trump is some sort of media superstar and hero. Remember, he had his time in the 1980's before the commercial real estate market went bust, and now he surfaced again in the early 2000's.

Nothing against Trump, but he is a symbol of conspicuous consumption and real estate speculation. And when that becomes something to look up to, watch out.

So my tongue in cheek measure is this: never trust a Trumped up economy.