An “affair” to remember

By Peter Coy

Big things are hard to steer, and there’s nothing bigger than the U.S. economy. Most of the time it grows, but when it doesn’t, presidents have precious little power to get it back on course. Reagan endured a recession; Clinton didn’t. That doesn’t necessarily make Clinton a better president than Reagan. The man in the White House a century ago, William Howard Taft, once said, “People think the president can make the grass grow and the skies turn to blue. It’s simply out of their reach.”

The deep recession that began under George W. Bush and continued under Obama was preordained, though few people understood so at the peak. Consumers had spent freely in the 2000s because a real estate boom had turned their homes into ATMs. Cash-out refinancings of home mortgages made the artificial real by transforming the illusory wealth of the housing bubble into actual goods and services. The debt burden eventually became unsustainable, and a retrenchment began in December 2007. What at first seemed to be an ordinary slump turned into a ferocious global crisis four autumns ago, when fears of hidden exposure to default caused the world’s biggest financial institutions to withdraw funds from one another.

At the peak of the crisis, the government did make a huge difference, without precisely turning the skies blue. Emergency measures by the monetary and fiscal authorities stabilized the global financial system, preventing a downward spiral into what might have been a second Great Depression. Once the crisis passed, though, it became clear that government’s ability to engineer a rapid recovery from a collapse caused by over-indebtedness was severely limited. The go-to reference during Obama’s term has been This Time Is Different: Eight Centuries of Financial Folly, a 2009 book that warns, “banking crises tend to be protracted affairs.”

Policymakers deserve a share of the blame. The White House, Congress, and the Federal Reserve all suffered from a failure of imagination — an inability to see that ordinary palliatives would not be enough to bring the U.S. out of its deepest recession since the 1930s. Tea Party adherents in Congress resisted temporary deficit spending, the standard Rx for an economy suffering from a shortfall in demand. The Fed worried too much about inflation in the early going: By selling short-term bonds to the market, it used its left hand to take away the stimulus it was supplying with its right.

As the chart at left makes clear, nothing in the past six decades compares with the slump we’re living through. Technically, the recession ended in June 2009, when output stopped shrinking. But when you’re in a deep hole, it’s not enough to stop digging. You must climb back out. That’s happening all too slowly.

Things are not as good as they appear when the economy is at a peak, nor as bad as they appear at the bottom. In late 2012 growth remains too anemic to catch up to the trend line. But the economy’s long-term trend is remarkably consistent — straight as an arrow, in fact. If history repeats itself, the economy’s growth rate will accelerate and the output gap will close. In other words we’re due — eventually — for a heck of a boom.


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