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Wednesday
Feb032010

Is there going to be an economic recovery, or is this the new normal?

I was born before WWII, and now is the first time it has ever occurred to me that we are in a recession from which we might not recover for a generation or more. I won't go into the reasons for my pessimism here, although I have written about some of them in previous posts. I write now only to report this recent insight and to point out that whether one assumes recovery or stasis should lead to profoundly different economic policy choices.

If we can have a recovery and resume economic growth and generalized prosperity in the near future, then it behooves us to use government fiscal policy aggressively and continue to keep money cheap to stimulate a recovery as rapidly as possible. The deficit accumulated to do that will be a much better thing to leave to the next generations than several unnecessary years—or a decade, or a generation—of stagnation, high unemployment, missed opportunities for education and career-building, declining international influence, etc., etc.

On the other hand, if this is the new normal, and we can't jump start the economy to perform like it did in the late 1990s, say, and we can't avoid a long period of high unemployment, stagnant family incomes, and declining prices—in other words, a lost decade or generation—then it would be better to start making now the painful adjustments that would be required to survive long-term in that environment. In this scenario, any stimulus money would add to the deficit but would have no expansionary effect. There would be not only smaller federal, state, and local government budgets, but smaller household budgets too. Infrastructure could not be expanded, properly maintained or replaced. Investment abroad might be more profitable than here. Funding for education would continue to decline, increasing the opportunity gap between rich and poor. The safety net for society's least vulnerable would be underfunded. Social Security benefits might have to be reduced, but there would be no employer-sponsored or private replacement—people would just have less to live on when they retire, if they can afford to retire at all. Net job creation would slow and could become negative. The average age of the population would increase as immigration of younger workers slowed and perhaps reversed, exacerbating the Social Security funding problem. The professional, managerial, and small business owner class could not avoid being sucked into this downward spiral, because the vast majority of their revenues come exclusively from what the others in their class and the 5/6 of American workers who are not bosses have available to spend. Real estate and other asset values would decline, and imported goods would become more expensive.

On this cusp of history, what we assume about the future may change what actually happens, which makes a wrong choice all the more perilous. If it is possible to pull out of the Great Recession only with aggressive stimulation, then doing too little or adopting policies appropriate for long-term stagnation might well foreclose the sunny path and assure the dark one. The Obama Administration seems to have chosen not to chose—it will not propose aggressive stimulation to help end the Great Recession, and it will not propose the painful policies that would be appropriate for long-term stagnation. We wait.

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