Baseline scenario

If you happened to catch Simon Johnson on Bill Moyer's Journal last week, you'll probably want to read his Baseline Scenario. A shorter, and slightly less technical version: We are gnawing on a shit sandwich of epic proportions, almost Carnegie Deli-sized.

Johnson, by the way is Dean Baker approved!

Today, however, he looks at how economic consensus, which can go unchanged for years, if not decades, can quite suddenly shudder and break in the face of new realities, and it can happen so quickly it's difficult to keep up.

We saw this last year with regard to discretionary fiscal policy - fiscal stimulus - in the US. Eighteen months ago, very few mainstream economists or other policy analysts would have suggested that the US respond to the threat of recession with a large spending increase/tax cut. The consensus - based on long years of experience and research - was that discretionary fiscal policy generates as many problems as it solves. To argue against this consensus was to bang your head against a brick wall, while also being regarded as not completely serious.

At some point in November/December 2007, this consensus began to shake. The history may prove controversial but my perspective at the time and in retrospect is that Marty Feldstein was the first heavyweight economist to question the consensus (including in interactions on Capitol Hill), and he was followed closely by Larry Summers’ influential writings in the Financial Times. Within a month or so, the consensus broke. Not only did we get a fiscal stimulus in early 2008 for the US, but the IMF quickly adopted the same pro-stimulus line globally and the terms of the debate changed everywhere. This fed into a process out of which came at least a temporary new quasi-consensus: a large US fiscal stimulus is part of the sensible policy mix today.

The consensus on banking just broke cover. For some weeks it has been under intense pressure. At least since the fall, serious people have been informally floating various new ideas on how to deal with the technical problems surrounding toxic assets and presumed deficient bank capital. But since mid-January, the mainstream consensus - that we should protect existing large banks and keep them in business essentially “as is” - seems to have cracked.

I wonder what the "consensus" is within the White House. "Nationalization" will be a tougher nut to crack then was even the stimulus package, and that is why, I suspect, Obama and Geithner are not yet prepared to use the term. As Simon notes, the banking industry has an enormous army of lobbyists at its disposal and is unafraid to use them. And I might add that this is true even if said lobbyists are now being paid by tax payers. You could see this over the weekend when Democrat Chuck Schummer thought nationalization would never happen, while Lindsay Graham seemed open to the idea. Schummber is not the only Democrat who regularly receives healthy donations from the banking/financial sector. So, Obama's significant political skills will be tested when this gets on the table, as he'll have to wrangle members of his own party along with the opposition, who will no doubt be hearing from konstituents yelling "fascism!111! Red Dawn!11111111!"