The “little depression” just got bigger

That´s the information we get from the BEA release. The picture below provides a clear visual impression.

A lot of people have already discussed this topic, so I´ll take a different tack. What amazes me is the fact that, led by “brand names” like Krugman, Laura D´Andrea Tyson, Robert Shiller and Alan Blinder, many insist on calling for more fiscal stimulus, even though the quite unproductive previous stimulus only succeeded in leading to the “great debt limit debate”. What about monetary policy? Only a few go down that (quite promising) alley because, after all, rates are effectively at the ZLB making monetary policy inoperative, unless the Fed feels that deflation is on the way, in which case Bernanke will switch the QE button to on!

In the picture below, the “Great Moderation” (GM) is clearly defined. Assuming that monetary policy played a significant role in bringing it about, it is not farfetched to assume that the blow-up of the “GM” was the result of monetary policy taking a “wrong turn” in 2008, converting a “normal” recession into a not so little depression.

If only we could have a “unified” view of the cause of the crisis – call it the result of monetary disorder – we would be, by this time, a long way into “solving” it. Unfortunately that´s not the case. There is a taxonomy, or “line of causation” that runs from the bursting of the house bubble to the financial crisis followed by the “Great Recession”. And it has become conventional wisdom to consider that in the case of an asset bubble and ensuing balance sheet recession that the recovery will necessarily be “long and painful”.

Laura Tyson expresses the thinking of many when she says that the “jobs crisis is the result of the collapse in aggregate demand (AD) that BEGAN with the financial crisis of 2008” (the Lehman affair). If instead we regard both the “financial crisis” AND the “jobs crisis” as the result of the fact that in the fall of 2008 the FOMC´s focus on disruption to financial markets rather than on the contractionary monetary policy in place intensified the recession, we would be closer to a “solution” to the “jobs crisis”. But no. The conventional thinking has it that there has been an unprecedented amount of monetary (and fiscal) stimulus and for some reason they think that only more fiscal stimulus will help job creation.

Maybe they are looking at the components of GDP (C+I+G+NX) and regard G as the exogenous variable that can be “freely” chosen to get GDP up. But we should remember that macroeconomics is about aggregates and that the Fed can (if it puts its mind to it) directly influence the path of nominal spending (and, to the extent that it is set on keeping inflation on “target”, easily offset the fiscal stimulus).

The recession of 1981/82 provides a good comparison. The drop in RGDP was much smaller, and is associated with only a reduction in nominal spending growth, something very different from what transpired in 2008 when worried sick about the rise in headline inflation due to the rise in oil and commodity prices, the Fed effectively tightened policy (despite “low” rates) causing nominal spending to register the steepest drop since 1938. RGDP growth tanked. Employment (NFP) growth also reflects the difference in spending growth in the two periods.

We are far south of the original nominal spending path. While this path may have become unattainable, we are still far south from any reasonable trend path. Getting to it is a choice the Fed can make but that is being held back by the inflation “paranoia” bubbling inside the FOMC. And while the Fed  “holds back”, the “hole deepens”.

Update: David Glasner puts it very nicely:

The current policy, like the half-hearted open market purchases of 1932 is a prescription for failure, but the failure is interpreted not as a failure to adopt an expansionary monetary policy, but as a failure ofexpansionary monetary policy.  In 1933 FDR proved, despite the skeptics, that expansionary monetary policy does work.  Why can’t we learn from FDR?  Where are all the historians of the New Deal?  Why aren’t they pointing out how FDR used monetary policy to start a recovery at the deepest point of the Great Depression?