Paul Lachine

Let it Bleed?

Once upon a time, policymakers understood that the government should tweak asset supplies to ensure sufficient supplies of liquid assets, safe assets, and savings vehicles, so that pressure to deleverage would not push production below potential output. But this basic principle of macroeconomic management has gone out the window.

BERKELEY – In the 12 years of the Great Depression – between the stock-market crash of 1929 and America’s mobilization for World War II – production in the United States averaged roughly 15% below the pre-depression trend, implying a total output shortfall equal to 1.8 years of GDP. Today, even if US production returns to its stable-inflation output potential by 2017 – a huge “if” – the US will have incurred an output shortfall equivalent to 60% of a year’s GDP.

In fact, the losses from what I have been calling the “Lesser Depression” will almost certainly not be over in 2017. There is no moral equivalent of war on the horizon to pull the US into a mighty boom and erase the shadow cast by the downturn; and when I take present values and project the US economy’s lower-trend growth into the future, I cannot reckon the present value of the additional loss at less than a further 100% of a year’s output today – for a total cost of 1.6 years of GDP. The damage is thus almost equal to that of the Great Depression – and equally painful, even though America’s real GDP today is 12 times higher than it was in 1929.

When I talk to my friends in the Obama administration, they defend themselves and the long-term macroeconomic outcome in the US by pointing out that the rest of the developed world is doing far worse. They are correct. Europe wishes desperately that it had America’s problems.

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