What  Have  We  Learned  from  the  Great  Recession?  

J.  Bradford  DeLong  U.C.  Berkeley  

January  7,  2011  

Five  Things  We  Knew  That  Turned  Out  Not  to  Be  True  

•  Three  years  ago  I,  at  least,  thought  that  all  of  these  were  true:  –  That  the  large  highly-­‐leveraged  banks  had  control  over  their  

risks.  –  That  the  Federal  Reserve  had  the  power  and  the  will  to  stabilize  

nominal  GDP.  –  That  as  a  result  fiscal  policy—automaUc  stabilizers  aside—no  

longer  had  a  legiUmate  countercyclical  role  to  play.  –  That  no  advanced-­‐country  government  with  as  frayed  a  safety  

net  as  America  has  would  tolerate  10%  unemployment.  –  That  no  maXer  what  theories  they  worked  on,  economists  had  

an  effecUve  consensus  that  the  government’s  proper  macroeconomic  role  was  to  intervene  strategically  in  asset  markets  to  stabilize  nominal  GDP.  

•  It  turns  out  that  none  of  them  are  true.  

That  the  Large  Highly-­‐Leveraged  Banks  Had  Control  Over  Their  Risks  

•  What  I  thought  three  years  ago:  –  American  commercial  banks  hit  the  wall  when  the  Volcker  disinflaUon  

interacted  with  their  petrodollar  recycling.  –  American  savings  and  loans  had  hit  the  wall  when  the  KeaUng  Five  gave  them  

the  opportunity  to  gamble  for  resurrecUon.  –  Otherwise  they  had  taken  every  shock  the  economy  could  throw  at  them  and  

come  through  successfully:  •  The  crash  of  1987  •  Saddam  Hussein’s  invasion  of  Kuwait  •  The  LTCM  crisis  •  The  Russian  state  bankruptcy  •  Assorted  EM  crises  •  The  collapse  of  the  dot-­‐com  bubble  

–  The  large,  persistent  equity  premium  strongly  suggested  that  financial  markets  lacked  paUent  risk-­‐bearing  capital.  

–  Thus  there  was  a  strong  argument  that  we  needed  more,  not  less  leverage  in  our  financial  system—since  risk-­‐bearing  appeared  to  be  a  scarce  and  valuable  factor  of  producUon.  

This  Turned  Out  to  Be  Wrong  

•  The  highly-­‐leveraged  banks  did  not  have  control  over  their  risks.  

•  They  did  not  even  know  what  their  risks  were.  •  They  appear  to  have  genuinely  thought  that  their  underlings  were  following  the  originate-­‐and-­‐distribute  business  models  that  they  were  supposed  to.  

•  And  they  had  taken  next  to  no  steps  to  give  their  high-­‐flyers  incenUves  to  look  out  for  the  welfare  of  the  firm.  

That  the  Federal  Reserve  Had  the  Power  and  Will  to  Stabilize  NGDP  

•  What  I  thought  three  years  ago:  –  That  the  Federal  Reserve  could  stabilize  nominal  GDP:  

•  Through  helicopter  drops,  if  necessary.  –  That  the  Federal  Reserve  would  stabilize  nominal  GDP:  

•  The  costs  to  the  Federal  Reserve’s  standing  and  to  its  self-­‐percepUon  would  ensure  that.  

•  This  turned  out  not  to  be  true:  –  That  NGDP  is  10%  below  its  pre-­‐2008  trend  has  not  been  of  any  great  concern  at  the  Federal  Reserve.  

–  That  the  FRB  has  not  been  staffed  up  has  not  been  of  any  great  concern  to  the  White  House  

That  DiscreUonary  Fiscal  Policy  Had  No    LegiUmate  Role  

•  What  I  thought  three  years  ago:  –  The  Federal  Reserve  has  the  power  and  the  will  to  stabilize  NGDP.  –  The  Federal  Reserve  can  act  and  affect  the  economy  inside  the  

congress’s  decision-­‐acUon  loop.  –  DiscreUonary  countercyclical  fiscal  policy  thus  has  no  role  to  play  

•  And  has  the  potenUal  to  confuse  people—congressmen  and  investors—about  the  long-­‐term  budget  plan.  

•  This  turns  out  not  to  be  true:  –  When  the  Federal  Funds  rate  hits  the  zero  lower  bound,  making  

monetary  policy  effecUve  becomes...  complex...  –  Government  purchases  then  have  a  role  to  play  as  a  form  of  spending  

that  does  not  have  to  be  backed  up  by  money  supply-­‐balances—the  government  having  the  lowest  spending-­‐to-­‐money-­‐balances  raUo  of  any  enUty.  

–  Government  debt  issue  then  has  a  role  to  play  as  a  way  of  keeping  open-­‐market  operaUons  from  offsedng  themselves  whenever  money  and  debt  are  close  subsUtutes.  

That  No  American  Government  Would  Tolerate  10%  Unemployment  

•  What  I  thought  three  years  ago:  –  American  governments  understood  that  high  unemployment  was  

social  waste.  –  American  governments  understood  that  high  unemployment  was  very  

hazardous  to  incumbents.  –  American  governments  simply  would  not  tolerate  10%  unemployment.  

•  It  turns  out  that  none  of  these  are  true:  –  Why?  –  I  had  five  theories:  union  collapse;  Washington  disconnecUon;  public  

scorn  at  the  rescue  of  the  bankers;  lack  of  trust  in  the  advice  of  a  split  economics  profession;  and  Nietzschean  ressenUment  of  a  sort.  

–  I  have  no  idea  which  is  true.  –  But  it  is  a  fact  that  the  standard  Washington  response  is:  “We  kept  

unemployment  from  reaching  15%!  Hooray  for  us!”    

That  Economists  Agreed  Governments  Should  Stabilize  NGDP  

•  What  I  thought  three  years  ago:  – Whatever  theories  economists  worked  on,  they  all  agreed  that  the  most  important  thing  to  stabilize  was  NGDP.  

–  A  sharp  fall  in  NGDP  would  call  forth  a  consensus  among  economists  that  the  government  should  do  whatever  was  necessary  to  get  NGDP  back  to  its  previous  growth  path.  

•  Once  again,  not  true:  –  The  economics  profession  is  badly  split.  –  And  here  I  have  a  big  problem:  the  arguments  of  those  who  think  that  we  should  simply  accept  the  fall  in  NGDP  as  part  of  what  Schumpeter  would  have  called  “a  healthy  cold  douche”  seem  to  me  to  be  so  far  from  contact  with  reality  that  I  can  get  no  purchase  on  them.  

So  What  Are  the  Lessons?  

•  A  modest  proposal:  should  “macroeconomics’  as  such  be  banned?  

•  Macroeconomics  should  be  taught  only  through  economic  history  and  the  history  of  economic  thought:  –  Start  in  1800  with  all  issues  of  what  the  business  cycle  was  or  might  become  open.  

–  Trace  the  developing  debates:  Say  vs.  Malthus,  Say  vs.  Mill,  Bagehot,  Wicksell  vs.  Fisher,  Hayek  vs.  Keynes.  

–  Should  we  stop  at  Tobin?