Policy Responses to the Depression--February 2-May 1, 2009--Part II

I turn to the remaining components of the current depression-recovery package.

(4) I argued in my book that the government was right to lend money to General Motors and Chrysler in December to avert their being forced to declare bankruptcy. The shock effect of such bankruptcies, and their potential effect on employment because more than a million workers are employed by these companies or their dependencies (dealers and parts suppliers), provided compelling reasons not only for keeping the companies from having to liquidate but also for keeping them from having to reorganize in bankruptcy, until the economy stabilized. For even if declarations of bankruptcy would not have resulted in the immediate liquidation of the businesses and thus the sale of their assets at distressed prices and the laying off of almost all their employees, the effect on consumer morale and willingness to buy cars from bankrupt companies might well have been profound. It was not worth taking that risk. The government bailout moneys thus purchased a kind of insurance policy against macroeconomic calamity.

The bailout worked. At a relatively modest, though by ordinary standards very large ($17 billion), cost to the government, the auto companies were kept out of bankruptcy until the acute psychological phase of the economic crisis had passed. Last December, and indeed until sometime in March, government officials, the media, and the public were understandably fearful that the economy was in free fall and might land somewhere near where the economy had landed in March 1933 (25 percent unemployment, output 34 percent below the GDP trend line, 18 percent deflation). Such a fear can constitute a self-fulfilling prophecy, because by causing consumers and producers to hoard cash rather than to spend, it can push the economy into a very deep downward spiral. That fear has now abated. Moreover, General Motors and Chrysler (and Ford as well) have in fact partially liquidated since December, closing many plants and laying off (for good, probably) many hourly and salaried employees, and terminating many dealerships. As a result of these drastic measures (but spread out over months, which reduced their psychological impact), the incremental shock effect of the auto companies' declaring bankruptcy has diminished greatly. And government promises to back any bankrupt automaker's warranties have begun to sink in and reassure consumers. Chrysler has just declared bankruptcy and GM may follow suit in a matter of weeks, yet the perturbation caused by the bankruptcy of the one company and the prospect of the bankruptcy of the other has been slight.

Concern has been expressed that, subject to possible modifications by the bankruptcy judge, Chrysler will be controlled by the United Auto Workers and therefore managed inefficiently, as worker-managed firms typically are. But it is not true that the UAW will manage Chrysler. Not the union, but the Chrysler retirement plan, will be a shareholder in the reorganized company (in fact the principal shareholder), and it will have a fiduciary duty to maximize shareholder value rather than to increase the earnings and benefits of the current workers. More important, whether Chrysler is managed efficiently or inefficiently has little macroeconomic significance. It is an unimportant company in a highly competitive global industry. If it is inefficiently managed it will disappear and its place will be taken by better-managed rivals in the United States and abroad. GM is bigger but its gradual disappearance would have no greater consequence for the economy as a whole.

(5) As of February 2, the House of Representatives had passed an $829 billion stimulus bill, which I analyze in my book. A couple of weeks later a slightly smaller bill ($787 billion) was passed by both houses of Congress and signed into law by the President. The differences between it and the original House bill are not great, but a disappointment is the reduction in the amount of money allotted to transportation infrastructure (mainly road and bridge construction and repair, and other construction and improvements, such as painting school buildings). As explained in the book, this is the class of stimulus expenditures that comes closest to satisfying the conditions for an effective Keynesian deficit-spending depression-recovery plan. It targets an industry in which the unemployment rate is high; most of the projects financed by it can be started quickly, in part because the states can use money they receive from the stimulus program to begin or resume delayed or interrupted construction projects; and there is an economic need, unrelated to the depression, for improvements in the nation's dilapidated transportation infrastructure. Hence the projects are likely to have value independent of their contribution to digging us out of present economic hole.

(6) Finally, there are the "stress tests" on the banks conducted by the government; the results of which are to be announced tomorrow. These tests are examinations of bank balance sheets to determine whether any banks need additional capital in order to survive a further decline in the economy, since a further decline, which is expected (especially in employment), will increase defaults on bank loans and thus reduce the value of banks' capital, of which loans are a major part. The tests themselves hardly constitute a program of depression recovery; they are a minimum precaution that the Federal Reserve and other bank regulators could have been expected to conduct in the ordinary course of their regulatory responsibilities, without publicity. The reason for the publicity is to reassure the public about the essential soundness of the banking industry and hence (perhaps) of the economy as a whole. Thus, it is a confidence-building measure, and restoration of confidence is a key goal of depression recovery.

Besides the categories of depression relief that I have discussed, there are plans for ambitious regulatory reform, intended to prevent a similar crisis in the future. I will discuss these plans in a future entry.