The Main Point

Macroeconomics is complicated and political economy is devilish, so it is easy to get lost in the details.  From time to time, it’s good to come up for air—to remember what the fundamental issue is.  In a way, the debate over structural versus cyclical factors invites us to do just that.

Suppose the current recession/depression is mainly structural.  Suppose it is due to an immense misallocation of capital and labor, a failure to foresee what our economy would really demand in the years ahead.  According to this story, we have trained too many masons and anthropologists and invested in too many building cranes and liberal arts colleges, and it will take years to shift our human and produced resources to more valuable pursuits.  (Actually, I think there continues to be an enormous misallocation of investment, but this will become apparent only when the threat of global warming is taken seriously.)  If the structuralist story is right, the ongoing slump is necessary and unavoidable and will end only when we have fashioned the resources for producing the right stuff.

If the cyclical story is predominately true, however, we have neither the wrong people nor the wrong capital stock.  We have all the ingredients it takes to have a vibrant economy that can fully employ our populations and generate a standard of living that surpasses what we had in the past and that keeps growing further.  But think about it: if we have the wherewithal to resume prosperity, what holds us back?  And why should rational people accept any excuses for policies that delay it?

Repeat: we have everything we need, right now, to restart our economies.  All the unemployment, the hardship, the lost opportunities are unnecessary.  That’s the main point.

The secondary point is about the why.  There are ultimately two reasons why economies like ours get stuck in a cyclical rut.  The first is that there is a reinforcing cycle of insufficient demand and insufficient investment.  This is where standard countercyclical policy comes in: through fiscal deficits the government increases demand on its own initiative, and through monetary easing an impetus is added to investment.  We are near the limit of what easing can do (diminishing returns to the QE’s), but not anywhere near the limit of fiscal expansion.

The second reason arises in balance sheet recessions: too much private borrowing has taken place, debtors find it difficult to sustain debt service, and both debtors and creditors retrench.  In this case, which is ours, the essential problem is that fulfillment of claims on wealth—both credit claims and equity claims on debt-related assets—interferes with the conditions required for restarting growth.  In other words, the shadow of past wealth creation is depriving new wealth creation of sunlight.  While respecting wealth claims is desirable during normal times, since it supports long-term planning, there come episodes in which a choice must be made between the past and the future.  This is such a time.  Wealth claims need to be trimmed, quickly and sufficiently, in order to reduce leverage and permit economies to return to growth.  We shouldn’t forget the main point, which is that economic growth produces the stuff of which real wealth is made, while satisfying the claims inherited from yesterday only allocates this stuff.  (And in a slumping economy the claims can’t be honored anyway.)

If you accept the cyclical story, and the evidence certainly weighs in its favor, you should not accept another month, much less year after year, of excuses for austerity.