December 04, 2014
I have to take some issue with Ezra Klein in his criticisms of Chris Rock. Ezra is upset with Rock’s suggestion that Obama would have been best off letting the financial industry and the auto companies collapse, and then picking up the pieces. Rock argued that Obama would have gotten more credit from this path than he is getting now for having bailed out firms and effectively muddled along.
Ezra responds that Rock’s plan is:
“morally odious: it would have meant putting millions of Americans through harrowing pain in order to help Obama out politically.”
He then argues that it would have given us a second Great Depression.
On the first point, I completely agree that putting millions of people out of work for political ends is morally odious. However, if we flip this over for a moment and make the question one of putting millions of people temporarily out of work for the ostensible longer term benefit of the economy, it would be much more difficult to call the choice morally odious. At least if we did, then we would have to say that most of the central bankers in the last century and the politicians who appointed them were morally odious.
It is central banking 101 that you raise interest rates to slow the economy and throw millions of people out of work in order to head off inflation. Paul Volcker is a hero in elite Washington circles precisely because he raised interest rates and threw millions of people out of work in order to bring an end to the inflation of the 1970s. To his admirers (which do not include me), the longer term benefits to the economy were worth the pain suffered by the millions of unemployed and their families. So the idea of throwing millions out of work to advance important economic ends is widely accepted in policy circles, even if most of us may agree that it is unacceptable to deliberately throw large numbers of people out of work as a campaign strategy.
This brings us to the more substantive issue of what would have happened to the economy had we gone the full crash route. Ezra gives us the Second Great Depression line, warning of bread lines, 23 percent unemployment, and that a worse financial crisis would be a harder to fix financial crisis. Let’s go through this piece by piece. (I will focus on the financial sector. I supported bailing out the auto industry since the loss of this sector would have meant a major and needless loss of productive capacity.)
Let’s assume that President Obama let the market work its magic and sink Goldman Sachs, Citigroup, Bank of America and the other Wall Street behemoths that were tottering at the time. It is undoubtedly true that the initial downturn would have been worse. A paper by Mark Zandi and Alan Blinder estimated that a financial collapse, with no offsetting fiscal or monetary response, would have raised the unemployment rate to 15 percent.
But then what? The Zandi and Blinder paper has a prolonged period of double-digit unemployment because there is no fiscal or monetary response. But why in the world would there be no fiscal or monetary response? Would Ben Bernanke be sitting around at the Fed celebrating the fact that inflation is under control?
And why would we not have any fiscal policy to stimulate the economy? In this world would Obama really be able to get zero stimulus through Congress? (Remember much of the Tea Party sentiment stems from the correct belief that Obama bailed out Wall Street.) Apart from Obama’s ability to get a spending based stimulus through Congress, would anyone really argue that Boehner and McConnell would run away from Obama if he proposed a huge tax cut that would give trillions to the rich?
In short, the Second Great Depression story rests on an absurd counter-factual where for some reason the people in positions of authority would just sit on their hands as tens of millions of people were out work. We have never seen anything like this in the post-war period. (The first stimulus was signed by President George W. Bush when the unemployment rate was 4.7 percent.)
The advantage of going this route would have been that we would have allowed the market to accomplish the goals of financial reform almost immediately, by eliminating the too big to fail banks and wiping out the speculators. An enormous albatross would have been removed from the economy. Would it have been worth the pain of millions more losing their jobs? That’s not easy to answer, but given that the economy is still down by close to 7 million jobs from its full employment level of output (applying demographically adjusted employment to population ratios from the pre-recession period) it is very plausible that financial crash route would have been better than the one chosen by the Obama administration. (It would have been best to have engineered an orderly restructuring of the banks that would not have required a collapse, but this would have been difficult politically.)
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