This blog has had two previous discussions
about the causes of the 2007 recession.
The first was a post on the merits of Keynes, Hayek, and Fisher in
providing an answer to the question of what caused the 2007 Great Recession. Despite the popularity of Keynes and Hayek in
popular editorials, the forgotten Fisher provides the best answer. Our country forgot the lessons of Fisher and
encouraged a bubble in real estate that caused the debt-deflation cycle that we have experienced for the last five years.
The second discussion was a post
on Roger Farmer on the role of wealth to create a productive society. Citing Milton Friedman, Farmer provides the
evidence that supports the view that employment tracks positively with wealth. The more wealth we have as a country, the
more employment we have. With more
employment comes more growth and more governmental revenues that provide more
services and reduce deficits and debt.
My own research supports the
Farmer position. However, instead of talking
about wealth, I use the term equity since I
use an accounting view of the economy. When
I look at a statement on the Gross Domestic Product, I see something that is
similar in large terms to a national income statement. And if the country has an income statement, there
must be a balance sheet. I found some
data and built a balance sheet going back sixty years. I analyzed it and saw how equity dropped
seriously in the 2007 recession and in the years following.
Equity is important because it creates the leverage that enables all of us to buy houses and cars and other
things. How many of us postponed a great
many purchases because we wanted to repair our own individual balance sheets
following 2007? Both Richard Koo and
John Taylor termed this effect as a “Balance Sheet Recession” in their
discussions of the Great Recession. If,
from a macro view, the national economy is a composite of our microeconomic behaviors,
then our 2007 recession and recovery should reflect the goals of rebuilding our
balance sheets.
This brings us to the Stimulus
package. If the cure to the recession is
to rebuild our individual balance sheets, then stimulus should enable that to
happen. What did the Stimulus package
do? First, it was a limited series of
tax cuts. Most people used the extra
money to pay down debt, which is good, but it failed to stimulate. In other words, the money was used to rebuild
individual balance sheets. Second, the
Federal government transferred money to the states to reduce program cuts. The Stimulus reduced the number police and
teachers that would have been laid off without the Stimulus. While this is a good thing, it is not stimulative.
In short, this action did not create
growth. The third was a package of road
and infrastructure improvements that took far longer to implement than was
planned, and the growth effect was diluted.
The sum of these parts is that the Stimulus package did not stimulate
very much.
The reason why this happened is
because the policy makers of the time from both parties, including many
economists, just got it wrong. The
administration assumed that the recession was basically the same as before. They did not ask if it was different, and the
administration recommended that the medicine from before would cure it.
The first economists who said otherwise
were Carmen Reinhart and Kenneth Rogoff in their book This Time is Different. They referred to 2007 as a financial recession
but they did not offer a prescription for curing it. We had to wait for people like Roger Farmer
to offer a suggestion.
We should also note that as the
recession continued, people on their own would improve their balance sheets,
which has enabled them to begin buying again.
Once we get back to a national debt/equity leverage typical of the years leading
up to 2007, then the economy will begin to approach pre-2007 growth levels.
If we knew then what some know
now, the recovery would have been different.
