There's a lot of talk about just where in the business cycle we are right now—are we close to hitting bottom?
I think economists can't tell whether we're near the bottom or not—it's the obvious reason why we disagree so much. It's not because some of us read the papers and others don't, it's just that we have different preconceptions and different ideas in our heads about how serious the downward pressures are and maybe different guesses about how strong the forces of recovery are going to be.
I think we’re going to be looking at a new reality. It would be a pipe dream to think we could get back to 4.5 percent unemployment such as we had in the middle years of the present decade.
Fair enough. But looking at these job numbers, consumer confidence, and other factors, is there anything that jumps out as significant?
Well, you know, we only see the tip of the iceberg. We don't see what's going on in corporate boardrooms, we don't see what's going on in the heads of entrepreneurs hoping to find a venture capitalist to back them, so we just have to make do with scraps of evidence. The fact that people are being fired at such a high rate is a serious sign that employers are bearish about the near-term future. They've thrown in the towel. On the other hand, there seems to be some strengthening in the capital-goods sector, construction is doing a little better, I gather, than before. One of the things that economists have noticed in recent months is that the historical data suggest that when firings start slowing down, they slow down very rapidly and the turnaround is not far around the corner, even when there's a lot of firing that's going on at present. One of the things we've noticed in past data is that even if firms are firing at a pretty fast rate, that may be the darkness before the dawn and it could be that the bottom is just two or three months away. So I don't think the economy telegraphs very clearly where it’s going.
People see this downward spiral, where unemployment goes up, consumer confidence goes down, and the two feed each other and wonder how things can get back on track. How do we break the cycle and jumpstart recovery?
That's a great question. Well, one reason why upturns follow downturns is that downturns tend to overshoot. People get panicky, they're afraid to stay the course, so they start selling. The other thing is that I think as entrepreneurs keep on waiting to produce new things that there's an accumulation of as-yet-unexploited new ideas that keeps mounting up. The forces tending to pull the economy up ultimately tend to be the match for the forces pulling the economy down, which are going to only push it so far when all is said and done.
Even if we didn't have new ideas that kept pinging the economy, and filtering in, the economy would only go down so far. It's not the case that this is an explosive downward spiral of higher unemployment breeds more pessimism breeds higher unemployment. Things can get only so bad. People want to eat, so at some point they resist further cuts to their consumption—it's not a bottomless pit. There's a rising stockpile, a mound of fuel developing, to power new projects and new investment activity. We can look for a much better level of economic activity two or three years from now once these projects are under way. A lot of new projects are being deferred because of uncertainty, but as the downward spiral peters out the uncertainty will wane.
But even if we do get back on track, is the economy of the previous decade, with its 4 to 5 percent unemployment, a pipe dream? Will we be looking at some new reality where what we consider a normal economy is something very different?
I think we're going to be looking at a new reality. It would be a pipe dream to think we could get back to 4.5 percent unemployment such as we had in the middle years of the present decade. For some time, I thought of the middle 1990s as a kind of benchmark year that was normal for its time, when the unemployment rate was about 5.5 percent, but now we've got two fundamental reasons why we can't even get back there. The first is that the financial sector and particularly the banking industry is in very bad shape. The balance sheets are very weak. They appear to be making a lot of profits these days, but it still is going to take years for them to build a strong equity position that will make them feel like taking on a lot of risk. The second problem is that households have lost a tremendous amount of housing wealth and the drop in housing prices is not going to be reversed. That was a bubble and I presume that the bubble won't regrow, so consumer demand is going to be weak.
Now in some people's theories, probably mine at a certain age included, that would be good news, because then investment would rush in and we'd have greater investment activity and faster growth. That's what we always wanted a few years ago when we thought consumers were spending beyond their means and investors were being starved and growth was threatened. People were saying, "Look at China where they save so much," etc., etc. But there are reasons why investment won't rush in fully to crowd in and take the place of consumer demand. For one thing, it's not a closed economy. Interest rates can fall only so much in the U.S. economy because we're operating in the global economy and in much of the world, not only China and India, but maybe Latin America to some extent, things are not as bad. This means that the weakness of consumer demand to some extent is going to create a weakness, causing a net decline of employment that will weigh down total employment.
From a policy perspective, do we need to do more to jumpstart the economy then? Some have suggested a second stimulus package.
We don't have a science of how to deal with crises and we can hope and expect to get wiser on the subject, but it's never going to be like making cookies or mixing a martini. It's always going to be very much a matter of insight, judgment, guesswork, and so forth. But my instincts are to oppose a second package of stimulus. First of all, we've hardly given the first package a chance because it was poorly designed and is just coming online now. By the time the first stimulus package has spent its wad, we can hope the economy will be on the uptick. The second reservation is that we don't really know how effective any given stimulus program is going to be. These stimulus programs are not homogenous: Some are pointed to consumer demand, some are oriented toward capital goods, and we have very little experience with the efficacy of public-works programs to step up demand for capital goods and related goods.
So to make one last point, I would prefer to go along with something that's safer and something we'd like to have around a long time to come which would be a system of low-wage employment subsidies. Some countries like France, Singapore, have instituted programs that pay employers for hanging on to employees, especially low-wage employees, so as to make employment higher than it otherwise would be. Singapore is having pretty good success with that program right now—output looks like it will fall by 9 percent but so far employment has held up. Why don't we do that in the U.S.? Would someone stand up and say what's wrong with it? I wish Larry Summers would say what's wrong with it. He's been sold on the idea it's too complicated, but in Singapore they did it right away in 24 hours, they connected it to the social security system, and it was done.
But to be fair, they have a much more authoritarian government—isn't it simpler to implement something like that once the order comes down from on top?
Things are no doubt a little simpler in Singapore than here, but I don't think the scale matters an awful lot.
You recently said that it may take 15 years to rebuild the wealth lost in the recession.
Yes, I was just making the point about weak consumption demand, that it matters on close analysis. Consumption is going to be weak as long as housing wealth and other wealth is weak, but the good news is that households are going to be rebuilding their wealth. They'll rediscover the habit of saving and, as it happens, that's bad news in the short run but it's good news in the long run because it means wealth will be rebuilt. As wealth is rebuilt, consumption demand will be buoyed up accordingly, and that will contribute to recovery.
Xtra Insight: Big Fat Story: 5 More Smart Takes on the Economy