"Worst since the Great Depression"

In a speech before the Brookings Institution on March 9, 2009, Christina Romer said that she has been uttering the words, "worst since the Great Depression" far too often. She is not alone. The words have been uttered by many politicians, economists, financial analysts, and just about everyone. The economy is down and seems to be sinking lower. Whatever measure we might use--unemployment, foreclosures, consumer confidence--we see a gloomy picture.

How are we doing on crisis management? In my view, not well. First, the economists. Keynesianism dominated the profession in the decades following World War II. Many economists believed we could fine tune the economy and select the level of unemployment that was associated with full employment by accepting a certain level of inflation. The stagflation of the 1970s destroyed that rosy view. Work by macroeconomists, both at theoretical and empirical levels, led to a rejection of the view that the answer to a recession was to increase government spending. The short-run multiplier associated with government spending was not that large, and the long-run effects tended to be nil or negative. In the current crisis, many prominent economists are arguing strenuously for massive increases in government spending. Let's return to the macroeconomics of the 1950s and 1960s and ignore everything we have learned since the 1970s. Since this is the "worst since the Great Depression," let's revert to depression-era thinking.

Second, the politicians. There has been a lot of talk about needing bipartisan solutions and approaches to government. Both parties have failed at crisis management. The crisis began as a credit crisis and a solution to the banking and financial sectors is needed. But the "fixes" for the financial sector have been inadequate and inconsistent. For all the talk of bold action, there has not been outlined a bold, consistent procedure to deal with the balance-sheet problems of banks. The stimulus plan includes many items that cannot be considered stimulative but actually represent the pent-up demand for programs favored by Democrats. Let's add autos to the mix, but also tell the auto makers how they should run their firms. Certainly a senator or representative knows more about making and selling cars than people who have worked in the industry for decades. It is easier and more fun to tell people how to run their businesses, or to fulminate over executive compensation, or to pass spending bills than to think seriously and hard about how to recapitalize banks and restore confidence in the financial sector.

Third, the public. You and me. We want quick answers. We want a riskless future and only good times. We want to be able to spend and buy any gadget that interests us without worrying about saving for the future. After all, rising home prices and equity prices should take care of our retirement. Oh, along with social security, medicare and senior discounts. We want it all!

Economics recognizes that we cannot have it all. There are opportunity costs to decisions and choices made. Choices have consequences, often unintended. Just because this is the "worst ______________ (fill in with your preferred term) since the Great Depression" does not mean that the choices we make will not have costs or consequences. Let's come out of the recession with more reasonable spending and saving decisions, and with an awareness that we cannot eliminate risk. We cannot have it all.