Thursday, May 3, 2012

Lessons of the Recession

Raghuram Rajan's book, FAULT LINES, is one of the best books I have read concerning the causes of the Great Recession. He now has an article in FOREIGN AFFAIRS that brings it forward. He goes over some ground covered in his book, arguing that the United States and other developed nations distorted markets for a couple of decades by making credit very accessible.  People's spending increased even as incomes didn't increase as much.  The bursting of the housing bubble induced households to deleverage, which was necessary.  For some of the European countries, it was government spending more than household spending that took place in the 15 years prior to the crash.  In neither case, Rajan argues, is the answer to increase government deficit spending.  We need to address the longer term problems.
Rajan's arguments run counter to the view that this is not the time to take the long view. We need to stimulate in order to get growth going. Once growth is back, then we can address the longer-term problems. Rajan argues against this on the grounds that the prosperity we had was not sustainable.  Further, the history of public policy has been to ignore the problems when we have prosperity.
He writes, "Fiscal austerity is not painless and will probably subtract from growth in the short run. It would be far better to phase reforms in over time, yet is is preceisely because governments did not act in good times that they are forced to do so, and quickly, in bad times. Indeed, there is a case to be made for doing what is ncessary quickly and across the board so that everyone feels that the pain is shared, rather than spreading it over time and risking dissipating the political will."
The whole piece is worth reading.

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