Wednesday, March 04, 2009

Liberal vs Conservative Economists and Predetermination

The interesting thing is how different experts break down the analysis of the financial crisis.

Democrats (or liberals), like Paul Krugman and Joseph Stiglitz see this crisis as a unique event, or possibly an analogue of the great depression. They have very good arguments for why its different than previous US recessions since WWII and compare the differences with the Japanese Lost Decade.

Pretty central to their arguments is the idea of a Liquidity Trap - originated by Keynes to help explain the Great Depression and a big focus of Krugman who created some of the main models for the Asian Crisis. The thumbnail is, when you have very low or zero interest rates, there's no incentive for people to invest. They may as well just hold cash. You can't make money any cheaper. Money doesn't get invested. Monetary policy is pretty much useless. You can't fix it like a normal business cycle because you can't spur demand with monetary policy by itself.

In a normal business cycle, when things slow down, stuff gets cheap, demand increases, and things get better.
When that doesn't happen, the monetarists (Milton Friedman) say it's the fault of the central bank like the Fed.
If there is inflation and that's the problem, you need to tighten and raise rates. Deflation, and you lower rates.
Money is just a flow and if the business cycle doesn't flow naturally, you need to unstopper the flow.

This idea really took off in the 70s when Friedman became THE economist for the right. When Reagan took office, inflation was huge and the economy wasn't good. Carter had been ineffectual. Volker as Fed Chief and Reagan took really bold (monetarist) steps. Like raising interest rates 10 points! That lead to a huge recession, but it did kill inflation and was followed by a mammoth recovery called the 80s.

SO: Republican's believe in the model of Reagan/Volker/Friedman. If they fixed the 70s, surely they must be on the right track, and all can be fixed by tax cuts (Friedman believed in zero taxes, though I think his arguments are less clear on that and tended to be more populist than analytical) and proper flow of the currency.

And the Dems like to look to the Great Depression which was the origin of modern progressive politics.
It has in it the justification for all the policies they have a hard time getting through otherwise.

As analytical as Economists on both sides can be (with all those percentages and case histories and what not), a liberal economist is going to say this is a unique or Depression/Asian Crisis type event and a Conservative Economist is going to say it's a normal business cycle (odds are), and all will be happy soon (if we cut taxes).

There are a few things that make the world very different now. You have to decide if it is different enough to disqualify a normal biz cycle analyis:
- Credit/Banking Crisis: Credit isn't flowing even when there's plenty of cash. So low interest rates won't help that.
- Interest Rates are already near Zero: The Fed can't tweak normal monetary policy any further.
- It's already longer than any postwar recession

On the "Normal" side:
We have had worse unemployment in the past and recovered. (Though things could/will get worse)
We don't have inflation. (Deflation is worse, but people argue about whether we have deflation)
Productivity (GDP per hour worked) is up.
Wages are actually up.

Personally, I take the NOT A NORMAL CYCLE view. This doesn't feel like something we just slid in to and can slide out of. It feels like major bad mojo that isn't fixed and is getting worse.

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