"Depression Lurks Unless There’s More Stimulus: Robert Shiller
Commentary by Robert Shiller
April 15 (Bloomberg) -- In the Great Depression of the 1930s the U.S. government had a great deal of trouble maintaining its commitment to economic stimulus. “Pump- priming” was talked about and tried, but not consistently. The Depression could have been mostly prevented, but wasn’t. Ultimately, the reason for this policy failure was inadequate understanding of the relevant economic theory.
In the face of a similar Depression-era psychology today, we are in need of massive pump-priming again. We appear to be in a much better situation due to the stronger efforts to date. Still, there is a danger that, because of a combination of faulty economic theory and inadequate appreciation of human psychology, as well as deep public anger, we will not continue with such stimulus on a high enough level.
We desperately need to be persistent, keeping our government response adequate for the problem at hand on a sufficient scale and for sufficient time.
George Akerlof and I lay out how economic theory needs to be changed in “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism” (2009). It shows that the most basic questions can only be answered if we take into account how psychology affects fundamentals such as our sense of fairness or corruption in our economic transactions, which helps determine how trusting or wary we are at any given time.
Following John Maynard Keynes, we call such motivations animal spirits.
Confidence is Key
Our theory of animal spirits is centered on confidence, and the vicious downward cycle of loss of confidence leading to decline in economic activity and then to more loss of confidence. This cycle is fed by the proliferation of stories of failure that spread like a virus by word of mouth over months and years. Moreover, our theory emphasizes that the sense that our society is basically fair can become wounded, and if that happens will not heal for many years.
In our analysis of the current economic crisis, we conclude that the government should have two targets. One would be a joint fiscal-monetary policy target. The same kind of expansionary policies embodied in the government expenditure stimulus and tax cuts that are already being tried have to be done on a big enough scale and for a long enough time in the future.
Following this target, aggregate demand should be sufficiently high that firms producing good products at a price the public would want to pay will be able to sell them. And if this target is met, skilled labor willing to work at a wage that makes it profitable to sell such products will be able to get a job.
The government should also have a credit target. Once again, we are calling for more of the same kinds of existing policies, but there should be an explicit measure of their success, and until that is reached, the scale and time frame of such policies need to be extended.
The Federal Reserve has to be the lender of last resort and to provide credit in circumstances like we have today. Businesses and consumers, who in normal times would be good credit risks with legitimate needs, should find credit available at reasonable terms. Achieving this requires new approaches, like those announced by the Bernanke Fed and the Obama administration, but on a continuing and even larger scale.
Outrage Creates Dangers
But we have lived for years in a system that tolerated the high-flying inequalities of the current financial system to play itself out, without protest. Where was the outcry then? Why should it not be much more generally targeted? We had two large tax cuts at the federal level that gave highly disproportionate tax advantages to those at the very top. It even gave special provision for extremely low tax rates, much lower than you or I pay on our regular wage income, to managers of hedge funds.
In this crisis, acceptance of these measures is being replaced with outrage. It is increasing the blood pressure of the public, and that can’t continue without damage to our system. Compensation practices in the U.S. need to be made fairer. Vast earnings shouldn’t go virtually untaxed, while the middle class is paying a sizable fraction of each extra dollar in taxes. Only then will the government have the mandate to restore our banking and securities institutions to their proper strong role in our economy.
It is now time to stimulate demand. It is also time to repair the credit system. Those are the two targets that must be hit to get us out of the current economic slump, and to restore confidence. It will be costly to meet both of these targets, and it will require new legislation to give enhanced regulatory powers to deal with a greatly changed financial system, now in a systemic slump.
It is time to face up to what needs to be done. The sticker shock involved will be large, but the costs in terms of lost output of not meeting either the credit target or the aggregate demand target will be yet larger.
It would be a shame if we are so overwhelmed by anger at the unfairness of it all that we do not take the positive measures needed to restore us to full employment. That would not just be unfair to the U.S. taxpayer. That would be unfair to those who are living in Hoovervilles in Sacramento and Fresno, California, and elsewhere; it would be unfair to those who are being evicted from their homes, and can’t find new ones because they can’t find jobs. That would be unfair to those who have to drop out of school because they, or their parents, can’t find jobs.
It is now time to keep our eye on the ball and set clear targets to fix a system that broke when our animal spirits got out of bounds.
(Robert Shiller is the Arthur M. Okun Professor of Economics and Professor of Finance at Yale University, and Chief Economist at MacroMarkets LLC. The opinions expressed are his own.)
To contact the writer of this column: Robert.firstname.lastname@example.org"