A map of the contrasts between 2012's different theories of what's ailing our economy and how we can fix it.
Since there's so much renewed focus on debates between those with a demand-side approach and those with a supply-side approach to what is wrong with the economy, I think it's a useful time to redraw my mapping of all the explanations of our crisis. I did this exercise in 2011, with a focus on different explanations of what is wrong with the economy and ways certain policies overlapped between them. I'm going to redraw this to emphasize the policy as it exists on a spectrum of options and give some new links.
The first approach is to say that we have a lack of demand in the economy. Those who believe this usually have three sets of policies for dealing with the weak economy: fiscal policy, monetary policy, or (mortgage) debt policy. Here are the three circles with a policy response spectrum for each of the issues. In general, the response on the right side of the arrow is more aggressive.
For those who want an explanation of how the three link together, some explanations include "Debt, Deleveraging, and the Liquidity Trap" and "Sam, Janet and Fiscal Policy," both by Paul Krugman, as well as "Consumers and the Economy, Part II: Household Debt and the Weak U.S. Recovery," by Atif Mian and Amir Sufi.
Some people put more of an emphasis on one circle versus another. Some think one will be the major factor, and some think another has no traction in the economy. In my humble opinion, it is useful to think of this as a three-legged stool. They all hang together, and contraction on any specific part of the three policies will require more expansion on another part to offset it. They are also all different battlefields policy-wise, requiring different agents and different arguments.
For those who would like to see the government run a larger deficit to increase spending, the big question is whether to just give people money (particularly in the form of tax cuts, but also through other means like food stamps and unemployment insurance) or to use the money to invest, hiring people to work on infrastructure and other public works. The multipler is believed to be larger when it comes to hiring people, plus it results in public works and other investments in our economy -- things like roads, bridges, schools, etc. That takes time, though. This debate goes back to the composition of the ARRA stimulus and continues today.
Chrstina Romer has an overview about what we know on fiscal stimulus. Dylan Matthews reviewed nine studies about the effects of the ARRA stimulus bill that was passed in 2009. On the other hand, as Karl Smith would say, "Why is the US government still collecting taxes when borrowing is cheaper than free?"
For monetary policy, the big debate is whether the Federal Reserve should engage in unconventional monetary policy through monetary instruments or by setting more aggressive targets. Paul Krugman gave a nice overview of the debate between these two approaches here.
Joe Gagnon wrote "The World Needs Further Monetary Ease, Not an Early Exit," justifying further action using monetary instruments. The larger case is that Bernanke can do more by guiding short-term interest rates than he could with the blowback he'd get from doing more aggressive targeting.
For the NGDP target group, Scott Sumner has been the best writer on this: see "Re-Targeting The Fed" and "The Case for NGDP Targeting: Lessons from the Great Recession." (A nice background on this movement is Lars Christensen's "Market Monetarism: The Second Monetarist Counter-revolution.") Brad Delong argues that a 2 percent inflation target is too low. Charles Evans's conditional higher inflation target is first alluded to in this speech of his; Yglesias covers his Brookings paper on his approach versus the instruments/guidance approach here.
Mortgage Debt Policy
For debt relief policy, the godfather of the "balance-sheet recession" view is Richard Koo -- see his "U.S. Economy in Balance Sheet Recession: What the U.S. Can Learn from Japan’s Experience in 1990–2005." To understand how mortgage debt and a balance-sheet recession is different than the wealth effect of people just feeling poorer from losing their housing value, see this interview with Amir Sufi. Adam Levitin has testimony about how to adjust bankruptcy to prevent housing foreclosures and better assign losses. Atif Mian, Amir Sufi, and Francesco Trebbi make the case that foreclosures are having a major real, negative economic impact in "Foreclosures, house prices, and the real economy." R. Glenn Hubbard and Chris Mayer argue for economic stimulus through refinancing here.
Meanwhile, on the supply side, there tends to be another three sets of policy arguments. One is that government policy is the issue, another is that governement budgets are the issue, and the third is that the labor force is the issue. Again, the issue on the right side of the spectrum should be considered the more aggressive approach in understanding the topic.
The first major cluster of supply-side arguments focus on the government budget and the deficits the government is running. These usually argue that private capital and job creators are sitting on the sidelines due to worries about government spending, future tax burdens, and/or a potential debt/solvency crisis. "Growth in a Time of Debt" by Carmen Reinhart and Kenneth Rogoff, as well as "Spend and Save" by Noam Scheiber, are places to start. These often go hand-in-hand with philosophical defenses of a program like the Ryan Plan and assaults on the social safety net (e.g. Yuval Levin's "Beyond the Welfare State").
At their most aggressive, these arguments say that short-term consolidation would expand the economy instead of shrink the economy. This "expansionary austerity" is less popular than it was in 2010-2011 (see David Brooks, "Prune and Grow") due to what is happening in Europe, though it still shows up. "A Guide for Deficit Reduction in the United States Based on Historical Consolidations That Worked" by AEI and "Large changes in ﬁscal policy: taxes versus spending" by Alesina and Ardagna are places to start.
Another aggressive argument is that any increased government spending would have to come at the expense of private capital, crowding out investment by definition. This "Treasury View" was a very common Chicago School argument against expansion in 2009, though is mentioned less now -- see Brad Delong's "The Modern Revival of the 'Treasury View.'"
Government policy arguments usually rely on the idea that economic performace is weak because of regulatory decisions made under the Obama administration, especially the passage of health care and financial reforms as well as regulatory decisions by the EPA. Suzy Khimm gives an overview of this argument and its political impact. Alan Greenspan is the most prominent advocate of this argument (see his paper "Activism"). Robert Lucas argues that Obama may have turned America into a social democratic country, which could explain the weak economy, in "The classical view of the global recession."
At the more aggressive end of this argument is the idea that the unemployment rate is high because the government is encouraging the unemployed to go on vacation (i.e. it's not a Great Recession but a Great Vacation). Instead of adding to background uncertainty, the government's policies are actively creating the unemployment they are trying to fix. See "Compassionate, But Inefficient" by Casey Mulligan and "The Dirty Secret of Unemployment" by Reihan Salam.
The other argument at the aggressive end is the idea that the level of GDP in 2007 was in a bubble, unsustainably high as a result of debt and/or bad sectoral allocations to finance and housing (caused solely by government policy, of course). A related argument is that the collapse of the housing bubble has permanently reduced U.S. potential output. See the arguments of James Bullard in the links here or here; it is also part of the main thesis of Raghuram Rajan's Foreign Affairs article.
The last cluster of arguments are centered around labor productivity. Some argue that we have an issue of labor mismatch. Our workers lack the skills necessary for high-tech 21st century jobs, or the recession has tossed the lowest productivity workers out of the labor force, or there are geographic and related issues that weaken our ability to match unemployed workers to job openings. See David Brooks here and Narayana Kocherlakota here for job openings, and Tyler Cowen's "10 Percent Unemployment Forever?" for the productivity argument.
The more aggressive version of this argument is that our problems are related to a lack of producitivty gains from so-called "protected" sectors of the economy, and without labor market reforms our economy cannot grow. Usually this is code for public sector workers; sometimes it means various growth-related government policy decisions (immigration, copyright/patents). This should properly be thought of as a long-term growth issue, though it is being folded into our current short-term economy by those who would make these arguments. David Brooks makes the case here; Raghuram Rajan makes a similar case in Foreign Affairs.
In general, the supply arguments have not held up well (remember when U.S. debt rallied on a ratings downgrade? good times), but here they are. Did I miss anything?
Mike Konczal is a Fellow at the Roosevelt Institute.
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