Costly caution

In a very depressing column, Martin Wolf asks an interesting question: what if the election of 1932 had in fact taken place in 1930, and what relevance does that have to the election of 2008?

Suppose that the US presidential election of 1932 had, in fact, taken place in 1930, at an early stage in the Great Depression. Suppose, too, that Franklin Delano Roosevelt had won then, though not by the landslide of 1932. How different subsequent events might have been. The president might have watched helplessly as output and employment collapsed. The decades of Democratic dominance might not have happened.

On such chances the wheel of history turns. But this time was different: the crisis brought Barack Obama to power close to the beginning of the economic collapse. I (among others) then argued that policy needed to be hugely aggressive. Alas, it was not. I noted on February 4 2009, at the beginning of the new presidency: “Instead of an overwhelming fiscal stimulus, what is emerging is too small, too wasteful and too ill-focused.” A week later, I asked: “Has Barack Obama’s presidency already failed? In normal times, this would be a ludicrous question. But these are not normal times. They are times of great danger. Today, the new US administration can disown responsibility for its inheritance; tomorrow, it will own it. Today, it can offer solutions; tomorrow it will have become the problem. Today, it is in control of events; tomorrow, events will take control of it. Doing too little is now far riskier than doing too much.” This was right.

The direction of policy was not wrong: policymakers – though not all economists – had learnt a great deal from the 1930s. Sensible people knew that aggressive monetary and fiscal expansion was needed, together with reconstruction of the financial sector.

But, as Larry Summers, Mr Obama’s chief economic adviser, had said: “When markets overshoot, policymakers must overshoot too”. Unfortunately, the administration failed to follow his excellent advice. This has allowed opponents to claim that policy has been ineffective when it has merely been inadequate.

This is not some idle, what if, thought experiment. It will have real, and disastrous consequences for years, if not decades, to come.

So what is going to happen? I assume that, after the midterm elections, resurgent Republicans will offer new tax cuts and ignore the fiscal deficits. They will pretend that this has nothing to do with any reviled stimulus, though it is much the same thing – increasing fiscal deficits, thereby offsetting private frugality. That would put the administration on the spot. It would have to choose between vetoing the tax cuts and accepting them, so allowing the Republicans to get the credit for their “yacht and mansion-led” recovery. Any recovery is better than none. But it could have been much better than this. Those who were cautious when they should have been bold will pay a big price.

Or, as Krugman puts it succinctly, by going Keynes-light, the Obama administration, abetting the "centrists" in the Senate, may have helped to damage Keynes' credibility when the next crisis hit (much the way FDR did in 1937, I'd add).

I'm not saying the stimulus that the administration did get through Congress isn't working. It is. It saved a million jobs according to the CBO and it is changing our infrastructure in meaningful ways. But it didn't do enough to lower the unemployment rate which in turn means it didn't do enough to bolster consumer confidence, which will likely continue to lag in to November. It's that on which elections turn, I'm afraid.