Learned Macroeconomic Helplessness

One of the oddest, most frustrating things about the six years plus since the Great Recession began is the incessant whining from pundits that it’s all very complicated, and nobody knows what to do. As Dean Baker says, the story of this slump is remarkably simple; I would give more role to household debt than he does, but basically yes, it’s a huge slump in housing. Here’s residential investment as a percentage of GDP:

Photo
Credit

This created a big hole in demand, one that couldn’t be filled with conventional monetary policy; so the answer should have been some mix of fiscal expansion, unconventional monetary policy, and debt relief. This wasn’t hard or unconventional economics; it was not much beyond Econ 101.

What about all the objections raised? Expansionary monetary policy would cause inflation! Budget deficits will drive up interest rates! We need to reduce deficits to encourage the confidence fairy! Two things: First, none of this came from the standard economic models, which said that money wouldn’t be inflationary in a liquidity trap, deficits wouldn’t drive up interest rates, and contractionary policy would be contractionary. And so it proved: low inflation, low interest rates, and here’s the effect of austerity from 2009 to 2013:

Photo
Credit

So basic models told us what to do, and the models have worked very well.

The only complicated thing about responding to this crisis has been the ideological unwillingness of influential people to take yes for an answer. We had the knowledge and the tools to have avoided most of the pain, but we didn’t, and instead cried “It’s all so complicated.”