Depression 2.0 Goes Global--Go Big or Go Home

Threads and storylines converge: the onset of the worst economic downturn in 80 years and the need for our new political leadership to go big when the confront this downturn.

The bad news keeps piling on, as Depression 2.0 goes global.

Increased jobless claims in the United States, German confirmation of a recession, and a new OECD projection all point to further economic contraction among the organization's member states:

Evidence of a broad global recession continued to accumulate yesterday, with U.S. officials reporting a spike in jobless claims, Germany confirming that its economy has shrunk for six consecutive months, and the Paris-based Organization for Economic Cooperation and Development projecting a contraction throughout its worldwide membership.

From broad indicators such as the demand for oil to the performance of individual companies, the signs point in the same direction: down.

"The OECD area economy appears to have entered recession," the organization said yesterday in a forecast that was stark in its breadth. OECD members include the United States, Japan, the major European economies and several other nations accounting for the vast bulk of the world's economic activity.

According to the group's latest forecast, the economies of the entire group are contracting and will shrink by a combined 0.3 percent in 2009. Its full-year forecast is for the U.S. economy to contract 0.9 percent next year; Japan to shrink 0.1 percent; and the organization's European members to shrink 0.5 percent.

UPDATE--Add 85,000 new foreclosures in October to the mix of depressing news items.

Paul Krugman argues that we see now the return of Depression Economics, where the usual tools of economic policy, for instance the Federal Reserve's manipulation of interest rates, no longer have traction in the economy. "When depression economics prevails," Krugman writes, "the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly."

In such circumstances, only a massive stimulus can suffice, spending without regard to the budget deficit in the short term:

To pull us out of this downward spiral, the federal government will have to provide economic stimulus in the form of higher spending and greater aid to those in distress — and the stimulus plan won’t come soon enough or be strong enough unless politicians and economic officials are able to transcend several conventional prejudices.

One of these prejudices is the fear of red ink. In normal times, it’s good to worry about the budget deficit — and fiscal responsibility is a virtue we’ll need to relearn as soon as this crisis is past. When depression economics prevails, however, this virtue becomes a vice. F.D.R.’s premature attempt to balance the budget in 1937 almost destroyed the New Deal.

Krugman continues:

What does all this say about economic policy in the near future? The Obama administration will almost certainly take office in the face of an economy looking even worse than it does now. Indeed, Goldman Sachs predicts that the unemployment rate, currently at 6.5 percent, will reach 8.5 percent by the end of next year.

All indications are that the new administration will offer a major stimulus package. My own back-of-the-envelope calculations say that the package should be huge, on the order of $600 billion.

So the question becomes, will the Obama people dare to propose something on that scale?

Let’s hope that the answer to that question is yes, that the new administration will indeed be that daring. For we’re now in a situation where it would be very dangerous to give in to conventional notions of prudence.

In other words, President-Elect Obama, go big or go home.

Michael Kinsley addresses some long-term considerations, and his prognosis isn't that bright and shiny. Kinsley writes:

“Consumer confidence” is plummeting nationwide. Those famous attitude surveys from the University of Michigan say so and actual consumption statistics confirm it. October retail sales were down double digits from a year ago. Most of this drop represents people who suddenly are poorer, or feel that way. But there also is some concern that the great American shopping spree may be over. We have all the stuff we need.

What do they want from us, anyway? Without consumers to lead the charge, an economic recovery will be hard to achieve. And yet everyone agrees that we need to start saving more. So should I buy that coffee maker to stimulate the economy? Or should I save the money in order to “grow” the economy and provide for my own old age? I can’t do both.

This is the dilemma that 30 years of Reaganomics (the real Reaganomics — keeping the economy overstimulated with huge deficits and irresponsible consumer borrowing — not the fantasy Reaganomics of government run like a family and tax cuts that pay for themselves) has left us with. So what do we do? The nearest thing to an actual plan seems to be something like this: stimulate first, to avert various short-term disasters, and then — at some signal from the Treasury Department — turn around and start saving like mad, to avert various long-term disasters. In other words, we need to get back our consumer confidence, and then lose it again.

The first part is fun. We just keep doing what we’ve been doing, only more and faster. The deficit may soar to $1 trillion a year while the government hands out cash to whoever shows up at the teller’s window. Each of us can do our own bit as well. Show your consumer confidence. One last shopping spree. Buy that coffee maker whether you want one or not.

Part II will not be fun. Return the coffee maker (if the store is still in business), and deposit the money in your 401(k). Start drinking instant.

Spending like crazy to stimulate aggregate demand is fine as a measure to end the crisis, but we shouldn't neglect to observe that Keynesian economics doesn't just mean countercyclical deficit spending in times of recession, but it also recommends building up savings during times of economic expansion. Over the long-term, then, our national savings rate must rise. (Like the so-called fiscal conservatives or deficit hawks say, we either pay taxes now or they must be paid later, by someone's children or grandchildren.)

The misery factor of Part II may be the reason Bush didn't ask the American people to sacrifice anything after 9/11, but rather asked them to take a trip or buy something: sacrifice doesn't add to aggregate demand. Which leads us to ask if a future of sacrifice will maintain real GDP growth? That is, if the national savings rate rises to pay down the debt, then those dollars spend for that purpose will not be available for consumption, and in those circumstances how can significant GDP growth be expected? The conventional answer is that these savings will translate into investment and thus expanded output.

That's the good news.

But what happens after may not be so pleasant. Maybe all those savings have to be allocated towards debt service.

The Dismal Science, indeed.