Arnold Kling, at EconLog, relates Scott Sumner’s simple query as to why the 2008 financial crisis has caused such low or negative growth down even unto the present day, and offers four possible answers. I will comment only on one of them:
Because the Fed made forecasting errors. Right-wingers are fond of brandishing charts showing that the unemployment rate with the stimulus is on a worse trajectory than what was forecast without the stimulus. That may or may not be evidence that the stimulus failed, but it is evidence that standard forecasts were not sufficiently pessimistic about the economy. Assuming the Fed used standard forecasts, that would explain the inadequate monetary expansion back then. It doesn’t explain their reluctance to expand now, though.
There are several places where this answer (which Kling does not favor) goes wrong. Most noticeable, to me, regards the possibility that the forecasts “were not sufficiently pessimistic about the economy.” This is not the only possibility. It is not even the most likely possibility.
The problem was that the forecasts were too negative, and the policy response too extreme and witless. Had financial collapse been allowed, and some major banks and other financial institutions — and a whole class of conceited Wall Street players — gone the way of the Brontosaur and the Dodo, the downturn would have been dramatic (housing prices would have collapsed, and a lot of real estate and credit default fortunes would have evaporated), yes, but the rest of us would have recovered pretty quickly. The nature of the boom-period pricing problems would have become apparent, since those who failed would have signaled their failure. Recovery would have started before the lawyers would have finalized the first few bankruptcies.
But that’s not what happened. Instead, we were forced to witness a self-fulfilling prophecy: The too-negative forecasts spurred on hysterical over-reaction, the bailouts. Which, in turn, covered up the semiotic function of markets, and generally disabled markets from clearing.
A more positive forecast — one untainted, say, by having friends in anguish at Goldman Sachs and Bear Stearns et al. — would have yielded saner policy, and better consequences.
This is a problem with the welfare state as it applies to government-businesss relations. You work regulatory expectations up to an unrealistic frenzy, where people think government is somehow “managing” things. This requires experts from the industries to get involved, with their own agendas. And they corrupt any reasonable attitude towards big business. They cannot help but pay favorites, because they — who live and breathe the industry the hail from — have favorites.
And folks in power becomes craven with fear, and foolish regarding policy. We lurch from an impossible-to-scale micromanaging regulatory scheme where businesses often are forced to endure expensive and crazy “oversight” by bureaucrats . . . to “welfare for the rich.” It’s absurd. Current policy could hardly be more idiotic.
Until we can let big businesses (including big financial institutions) fail, America will stagger among several competing policies, with no coherent sense. Consequently, the general signal to market participants will remain incoherent.
And, amidst such regime uncertainty, nothing like a thriving business environment, or “full employment,” will be achieved.