Not Since the Depression?

The Washington Post's Dan Balz writes:

After a victory of historic significance, Barack Obama will inherit problems of historic proportions. Not since Franklin D. Roosevelt was inaugurated at the depths of the Great Depression in 1933 has a new president been confronted with the challenges Obama will face as he starts his presidency.

Hmm... unemployment is currently at 6.1%; I wouldn't be surprised to see it rise by January, but it is unlikely to be much worse than when Clinton was inaugurated in Jan. 1993 (7.3%) or when Reagan took office in Jan. 1981 (7.5%).

Financial crises occur with some regularity; this may be the worst since the depression, but Clinton and Reagan faced other problems.

When Clinton took office, the Federal budget deficit was over 4% of GDP and investment was slumping. The deficit has re-emerged as a problem recently, but it has not reached the chronic severity of the 1980's and 1990's, when it became a central political issue (remember Ross Perot and Paul Tsongas?).

Inflation was in double-digits when Reagan entered office, and the Volcker Fed had embarked on a painful effort at disinflation which entailed extremely high interest rates (the Fed Funds rate exceeded 19% at a couple of points in 1980 and '81).

So, yes, problems of "historic proportions" await President-Elect Obama: he will confront problems of roughly similar proportions to those faced by other Presidents in recent history. I'd guess a little worse than '93 but not as bad as '81. We didn't start the fire...

Update: Floyd Norris on the Reagan parallel.

Update #2 (11/7): Unemployment rose to 6.5% in October. The level is still modest by historical standards, but the change looks bad, according to Krugman:

The unemployment rate has now risen more than 2 percentage points from its pre-recession low. In 1990-1992 the unemployment rate rose 2.6 percentage points. Given what’s happening to retail sales, manufacturing, and so on, it’s now a certainty that unemployment has a lot further to rise. So the “worst recession in 25 years” thing is now baked in. The only question is whether we hit “worst slump since the Great Depression” territory.

The unemployment rate rose from 4.6% in October 1973 to 9% in May 1975 and from 5.6% in May 1979 to 10.8% in November 1982, increases of 4.4 and 5.2 points respectively. If we take this cycle's pre-recession low as 4.4% in March 2007, we need to get to 9.6% to be in "worst since the depression" territory by the change metric, and 10.8% by the level metric. Either way, still a long way to go (yes, I am ignoring underutilization; this is important but the data don't go back as far. I would expect that the trends would be similar, though; i.e. that past recessions also saw increases in underemployment).

Update #3 (11/9): Justin Fox notes that the combined September-October job loss amounts to 0.38% of total employment.

Democratic Econ Policy Kumbaya

When President Clinton took office, he was forced to choose between keeping campaign promises of more public investment and middle-class tax cuts or focusing on deficit reduction. The conflict played out among his advisors, with Robert Reich representing the former "traditional Democratic" view and Robert Rubin taking the "Eisenhower Republican" side, which ultimately carried the day.

That is a useful reminder that an administration's policies can take a very different direction from what a candidate promises or expects. However, if Barack Obama wins tomorrow, it appears he will not face such fundamental differences of opinion among Democratic policy advisors. In the Times, Robert Rubin and Jared Bernstein (of a left-ish think tank) were able to smooth over the differences enough to write a joint op-ed.

Though if one reads carefully, it seems the smoothing over is not quite complete; for example, they write:

In more stable times, a budget deficit equivalent to roughly 2 percent of G.D.P. will keep the debt-to-G.D.P. ratio constant, a legitimate fiscal policy goal. In flush times, a smaller deficit would lower the debt ratio and that might be desirable.

"Might be desirable"? Sounds like something written by two people who don't fully agree...

Anyhow, Ezra Klein says:

[W]hat you can see, at least in the short-term, is an incredible level of consensus on large scale stimulus targeted at infrastructure investment. And this sort of elite unanimity matters, as all manner of wavering congressfolk will go to their chosen sage and get the same answer, rather than being divided by slightly esoteric, intra-wonk rivalries.

Matthew Yglesias writes:

The real question going forward will be whether self-described centrist legislators are willing to heed the advice of Rubin, Summers, and others about the essential need for stimulus, for new spending on infrastructure, and for major investments in health care and education or whether they’re going to choose to play the role of spoilers and try to grab as much special interest cash as possible for their troubles.

See also: EconomistMom, who says "we can get along." (yes, we can?)

The 18th Brumaire of the Rational Expectations Revolution?

As the financial crisis and incipient global slump only reinforce our appreciation for Keynes - in "textbook Keynesian" form and otherwise - the peerless YouNotSneaky calls for macroeconomics to throw off the shackles of the dynamic, optimizing rational expectations paradigm that is the legacy of Lucas et al. In support, he (she?) invokes the famous billiard player analogy from Milton Friedman's "Methodology of Positive Economics" -

What have they brought us? It is true that our texts were fallible. And it is true that, in the beginning, their critiques shone light upon our misunderstandings. But we mistook a lighting of a candle for a conflagration of divine knowledge. And ecstatic with a small dose of illumination we threw our books upon Savoranola’s fire. Even Michelangelo himself threw his Madonnas onto the pyre (find a relevant link yourself. All I get is wiki).

Yet in end, their promises fizzled once the glow of the ambers died. Having abandoned our faith we were left with trying to build a house out of ashes – micro founded ashes – rather than ad-hoc oaken beams. It is time. It is time we returned to the practical knowledge which had allowed us to built a shelter, no matter how shabby, but which could stand up well in the hail storms, even if we did not understand the engineering principles involved. A good pool player knows how to sink the final ball in its pocket at the end of the game, avoiding the eight ball. The knowledge of the laws of physics is immaterial. Perhaps if the game was played on a table with no friction our detractors would have had something useful to say.

But we have been in the wilderness for a long time. We are weak. It is the truth and let us admit it, our spirits have been starved of intellectual substance for some time. And they may be for some time yet. But our path is righteous. And if we are going to ever get back upon it we need to first assert our own existence. We are MACROECONOMISTS! We have insights which cannot be derived from the cult of Some- kind- of- Maximization- somewhere- by- somebody- for- some- reason (and who knows who or what) = Microfoundations.

Read the whole thing (this means you, Econ 617 students).

Chin Up, People!

The Times reports:

Consumer confidence fell to its lowest level in at least 40 years, a survey said Tuesday, as falling home prices and steep declines in the stock market took a sharp toll on the faith of Americans in the economy.

A widely watched survey by the private Conference Board, which dates back four decades, plunged to its lowest reading on record in October as Americans reported fewer jobs and smaller incomes and curtailed plans for major purchases like cars and appliances.

Americans also say they believe the economy will worsen before it improves — a sign of deeply engrained pessimism that reflects a year of painful declines in stocks, jobs and home values....

Lowest in forty years? Lower than 1981-82? 73-74? We have a long way to go before it's that bad, and I doubt things will get that far.

We Are All Keynesians Now

Robert Lucas: "I guess everyone is a Keynesian in a foxhole." From Justin Fox, "The Comeback Keynes" (extended quote here).

Apparently you can't get out of a foxhole by assuming a ladder...

Flight to Safety?

One of the bigger ironies of the financial crisis is that the US has troubled financial institutions, a plunging stock market and a ballooning government budget deficit and demand for our government bonds is increasing: (keep in mind that the price and yield are inversely related). And now we also see a spike in demand for our currency: (foreign currency per dollar). Even the presumably relatively safe Pound and Euro took a plunge last week: (note that the scale is opposite, so the Dollar is still appreciating). However, the Japanese Yen seems relatively immune, relative to the Dollar, which means it is also jumping in terms of other currencies: In troubled times, demand for assets deemed "safe" (or "liquid" or "quality") traditionally goes up, which is why things like emerging market debt and junk bonds often suffer, regardless of the virtues (or lack thereof) of the issuers. But it is quite remarkable that, for all that is going wrong in the US, we are still on the receiving end of this flight to safety effect.

How much of this to attribute to virtue versus good fortune is a good question for international economists and economic historians to contemplate. More immediately, despite all their prudent reserve-building since the crises of the late 1990's, emerging markets are once again getting hit hard. Dani Rodrik sees an urgent need for IMF action. See also Arvind Subramanian, Brad Setser and Naked Capitalism.

From a US standpoint, although we are better off with a flight into, rather than out of our currency and assets (which would cause a huge spike in long-term interest rates), the Dollar's rise is hardly benign. Until recently, the mostly-non-panicky drift downward of the Dollar was helping turn around the current account deficit - a sustained move in the other direction would be trouble for exporting and import-competing industries (indeed, Rodrik fears this could lead to protectionism).

Another Devil in the Details?

The Treasury is using its recapitalization to encourage consolidation in the banking sector, but it is not doing anything to force banks to actually lend money, according to the Times' Joe Nocera:

On Thursday, at a hearing of the Senate Banking Committee, the chairman, Christopher J. Dodd, a Connecticut Democrat, pushed Neel Kashkari, the young Treasury official who is Mr. Paulson’s point man on the bailout plan, on the subject of banks’ continuing reluctance to make loans. How, Senator Dodd asked, was Treasury going to ensure that banks used their new government capital to make loans — “besides rhetorically begging them?”

“We share your view,” Mr. Kashkari replied. “We want our banks to be lending in our communities.”

Senator Dodd: “Are you insisting upon it?”

Mr. Kashkari: “We are insisting upon it in all our actions.”

But they are doing no such thing. Unlike the British government, which is mandating lending requirements in return for capital injections, our government seems afraid to do anything except plead. And those pleas, in this environment, are falling on deaf ears.

Yes, there are times when a troubled bank needs to be acquired by a stronger bank. Given that the federal government insures deposits, it has an abiding interest in seeing that such mergers take place as smoothly as possible. Nobody is saying those kinds of deals shouldn’t take place...

We have long been a country that has treasured its diversity of banks; up until the 1980s, in fact, there were no national banks at all. If Treasury is using the bailout bill to turn the banking system into the oligopoly of giant national institutions, it is hard to see how that will help anybody. Except, of course, the giant banks that are declared the winners by Treasury.

It is worth noting that the Canadian banking system, which is an oligopoly of giant national institutions, appears to be holding up quite well.

The End of the 1980's?

Since the 1980's began when video killed the radio star, perhaps that is the wrong medium to declare their end, which I did in a commentary for the local NPR station:

Ronald Reagan was fond of an aphorism attributed to Thomas Jefferson: the government which governs least, governs best. During the debate over the financial rescue, one Republican Congressman described the legislation as a coffin on top of Ronald Reagan's coffin. That the proposal he was criticizing came from a Republican President and his Wall Street treasury secretary shows how much things have changed.Regulation is not the only area of economic policy where the 1980's mentality is coming to an end. The so-called supply side economics that motivated the tax cuts under Reagan and George W. Bush has also been discredited by events...

Info-Graphic

This "interactive graphic" of US economic indicators from the Times is truly impressive.

Bernanke, white knight upon a firey steed?

"Helicopter Ben" rides to the rescue.

And yes, I believe those are the helicopters from "Apocalypse Now" - who doesn't love the smell of swap lines in the morning? (Hat tip: Mankiw)