Wednesday, July 13, 2011

Why it's a "hard slog"

Past director of the Office of Management and Budget in the Obama administration Peter Orszag points out, (without explaining why), that: "Recoveries following financial collapses tend to be frailer than those associated with other sorts of economic declines." and so predicts much more of "Hard Slog" than shows up in conventional projections.

When there is a financial collapse the financial institutions and their well to do clients and employees successfully argue that their own recovery is the critical precondition to a broader economic recovery. Monetary stimulus, by its nature, normally benefits them first in any case. Fiscal stimulus in the forms of bailouts, rule relaxations and tax benefits, however, work powerfully to put the interests of Wall Street ahead of Main Street. This sector gains disproportionately while the real economy languishes. I am personally convinced that the broad economy would have been much better served by bankruptcies and liquidations of the supposedly "too big to fail" institutions. That by itself would not have directly helped main Street businesses but they were not being helped anyhow. They would have in time benefited by the creation of smaller financial institutions more responsive to their needs.

One of several valid ways to diagnose macroeconomic problems is to cast them all as essentially problems of misallocated resources. The pre-bubble economy suffered from grossly excessive allocation of resources to the financial sector. We have largely missed the opportunities to correct that misallocation, as typically happens in the case of financial crashes, and that is why recoveries of this type are such a hard slog.

"We did a pretty good job of fixing bank balance sheets, but I think that household balance sheets are the ones that have suffered the most," said Mark Thoma, a professor of economics at the University of Oregon. "We could have done much more to help households."

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