Wednesday, February 04, 2009

Dissatisfaction- War on Two Economic Fronts

The war on the recession is primarily taking place on two fronts. Neither front is going very well.

1. The aggregate demand front. As consumer spending contracts government needs to spend more to stimulate aggregate demand.

Larry Summers, Obama's chief economic adviser, is concerned that if it isn't passed ASAP we will be in a real deflationary spiral.

Marty Feldstein, Obama supporter and current president of the NBER, decries the current legislation as-written for being too slow in doling out funds to longer-term projects and having too many provisions for tax cuts that won't stimulate the economy very quickly. He thinks we should call "time out" and get it right.

So, there is a lot of frustration.

2. The money multiplier front. Banks are still not very solvent. They still have too many bad assets on their books and do not want to write them down to zero and be cleaned out.

But, pretty much everyone from Ken Rogoff to Paul Krugman have decried the bailing out of banks without cleaning out their shareholders.
"authorities should be prepared to allow financial institutions to be restructured through accelerated bankruptcy, if necessary placing them under temporary receivership, and only then recapitalizing and reprivatizing them." (Rogoff)

Instead, the U.S. Treasury is seemingly more interested in propping them up. Discussion of the creation of a "bad bank" to buy up troubled assets so far has seemed to sidestep the issue of "nationalisation." Rogoff and (many) others see putting these banks in a receivership (as was done with the S&Ls in the late 1980s) as a necessary painful option.

So, we throw a bunch of ideas around and little gets accomplished either way. We could be in deep trouble (sooner rather than later). Or maybe not.

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