Cliff Notes

The length of a recession is officially measured by the National Bureau of Economic Research (NBER) as the time from the previous peak in economic activity to the nadir (trough). This recession, known as The Great Recession, lasted 18 months according to the NBER, from December 2007 until June of 2009. Seems like forever. The recovery has been phlegmatic compared to typical post war recessions.  The cause(s) of this recession were not typical and were characterized by a severe financial crisis. Academic research indicates that the private deleveraging process required to recover from a crisis of this type typically takes several years (See Rienhart and Rogoff “This Time is Different: Eight Centuries of Financial Folly” 2009). We are doomed to a typical recovery. Our potential recovery is complicated by perceptions of the risks associated with our high level of public debt, particularly federal debt.

 It is obviously naïve to expect politicians to clarify issues surrounding the present state of the economy They have not disappointed.. The role of political philosophy colors the debate. Ideology prevents reasonable discussion and the weighing of evidence. The mavens of the left overstate the benefits of intervention and those of the right deny the possibility of benefits and see only negative consequences. How about a discussion based on logic and/or evidence rather than quasi-religious beliefs?

Simply put the “fiscal cliff” is a combination of tax increases and expenditure cuts designed to reduce the deficit by about 50% immediately. If this combination sounds like the European approach to their fiscal crisis, that’s because it is. We can observe how well it’s doing there. Why should we be different? There is no reason why. The Congressional Budget Office (CBO) estimates the effect of making the leap as a one-half percentage point reduction in the growth rate( or about $80 billion a year in GDP loss) with a high probability of a recession in 2013. So the price is lost output and increased unemployment. The economy returns normal growth (from a lower base) by 2015 according to projections. The gain is a lower cumulative deficit in the ensuing years. But the accumulated output loss adds insult to injury and insures that this accumulation will take years to overcome. The price is too damn high.

Larry Summers and Christina Romer have argued convincingly (April 2012) that more stimulus now with a real long-term plan for fiscal rectitude will achieve greater growth at less short-term cost. Makes sense to me. Sometime you have to strengthen the patient before performing the surgery.

More fiscal stimulus at this time with continued Quantitative Easing by the Federal Reserve has the possibility of giving the economy the jolt it needs to continue its revival even though global growth is slowing down. This prescription is the only game in town. Krugman and some other lefties have argued for a more aggressive monetary policy by the Fed. They would like the Fed to raise the target rate of inflation (currently 2% per year to 3 or 4%). They argue that raising the explicit target would encourage more consumer and business spending as there would be an expectation of more inflation, hence a fear of depreciating currency. I sympathize with this argument but it is not without risk. Once in place, inflationary expectations are hard to reverse, and there is a danger of overshooting the target. Let me just note at this time that the tighter monetary policy necessary to reduce inflation is not without significant costs.