In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.
Right now the economy is benefiting from these policies. We've seen an increase in PCEs, retail sales, ISM indexes, regional Fed indexes, investment in equipment and software and exports. This has culminated in three quarters of GDP growth.
In short, we're at the beginning of a recovery. All we have to do is keep doing what we're doing.
However,
As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.
The continuation of the recovery is dependent on politicians doing the right thing. Last week's debate about unemployment benefits was without a doubt one of the most Kafkaesque events I have ever witnessed in my lifetime. Not since someone floated the idea that we can win a land war in Asia has Washington done something so mind-numbingly stupid.
What I find most disturbing is how incredibly stupid and ignorant Washington is about simple economics. I have posted the GDP equation several times to illustrate how incredibly ignorant the "government spending can't help" argument is; it is purely counter-factual and exists only in a the realm of political dogma. Yet that does not stop this incredibly idiotic argument from gaining traction in political dialog.
I don't think the situation is as dire as Krugman argues. He is prone to hyperbole. Most importantly, he is using his perch to make a political point in a language that drives people to action. I do think Washington has demonstrated beyond a shadow of a doubt that they are stupid beyond belief.
For me, the jury is still out. There are plenty of strong economic numbers out there still (see the ISM manufacturing and service numbers, regional Fed numbers, PCEs, real retail sales, etc..). however, last week was incredibly disappointing from a political perspective and indicates Washington lowers IQs and both political parties are filled with idiots.
