Why we always look back to solve present problems?

20Oct12

“the aftermath of crises is usually a bad time. But that’s because the policy response to crises is usually lousy. We are repeating that story — but we shouldn’t.” by Paul Krugman @NYTimes Blogs

Bubble, Bubble, Conceptual Trouble

We’re living in the aftermath of a major financial crisis. Reinhart-Rogoffwarned in advance that recovery was likely to be slow; so, with less historical detail, did I. And so it has proved.

But based on the discussion I’ve heard, both on the blogs and in forums like that House of Commons debate Monday, there’s a lot of confusion even among economists about what the pattern of slow recovery from financial crisis is really telling us. Basically, there seems to be a confusion between saying that something is usual and saying that it is necessary. Those aren’t the same thing.

Here’s how I interpret what we see in the historical data: financial crises leave an overhang of private-sector problems, principally excessive debt on the part of some subset of economic agents — households, in the case of the United States. Because these agents are either forced or strongly induced to slash spending, the “natural” rate of interest, the interest rate consistent with full employment, falls sharply — and in the case of a severe crisis, falls well below zero.

What this means in turn is that conventional monetary policy, which normally bears most of the burden of economic stabilization, is no longer up to the job.

Now, there are other policy options. You could use discretionary fiscal policy, a k a stimulus, to boost demand; you could use unconventional monetary policy to depress interest rate spreads and/or raise expected inflation, helping get past the zero lower bound problem. Historically, however, countries tend not to do these things, or not to do them on a sufficient scale. Why? Politics. Intellectual confusion. Inertia. Misplaced fears.

Basically, it takes much more clarity and unity to pursue either discretionary fiscal expansion or unconventional monetary policy than it does to cut the Fed funds rate, and few countries manage to display that kind of clarity and unity. And that, in turn, is why it took a war to end the Great Depression; there’s nothing special about military spending from an economic point of view, but as a political matter Hitler managed to override the usual objections to stimulus.

Which brings me to the conceptual confusions.

 Read the full article here

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