The Issues: The Economy

Megan McArdle and Ryan Avent compare recessions and depressions, revisit the housing bubble and the banking crisis, consider the future of the 401(k), and ponder whether Obama can prevent a repeat of the 1930s

RYAN AVENT: Ok! The economy: what is the deal?

MEGAN MCARDLE: That's a great question, Ryan. And if either of us REALLY knew the answer to that, we'd be keeping very quiet and getting rich
So, let's start with the big one
Are we in a recession or a depression?

RYAN AVENT: That's the question, isn't it?
Well, I suppose there are technical definitions for depression out there
I believe a popular one is a 10% drop in GDP in one year, which would suggest we are not

MEGAN MCARDLE: Part of the problem is that, as far as I know there isn't an agreed on distinction

RYAN AVENT: It's kind of, like, worse than recession

MEGAN MCARDLE: Other than the old saw that it's a recession when your neighbor loses his job, and a depression when you lose yours

RYAN AVENT: In that case, maybe we are so far, then, still in recession territory


It is clear that this is something more than a garden variety recession, though
How much more remains to be seen

MEGAN MCARDLE: I'm leaning towards the D word
The depth is bad, but what I'm worried about is the length.
I feel like, postwar, we basically understood how we got into the recessions and how to get out again, through a combination of fiscal and monetary changes

RYAN AVENT: That's an interesting point, but I wonder to what extent the knowledge is colored by hindsight

I think in 1980, for example it was very clear what happened


MEGAN MCARDLE: Paul Volcker shot interest rates up to 20%--

RYAN AVENT: Volcker happened

MEGAN MCARDLE: ...and when they came down again, the recession eased
Simple fluctuations in aggregate demand driven by tighter money

RYAN AVENT: And then that became the model for recent recessions

MEGAN MCARDLE: This is not such a fluctuation
Even in 1974-5 you had a clear cause in the oil shocks
It wasn't necessarily comforting, but at least it was comprehensible

RYAN AVENT: But do we think that the current downturn hearkens back to some earlier brand of recession or is a new phenomenon entirely?

MEGAN MCARDLE: My current theory, which is fairly unsatisfactory, is that every sixty years or so, in a developed economy with a decently stable financial system, a number of factors collide to produce a perfect storm that causes problems in the financial system, and a very prolonged economic readjustment

RYAN AVENT: I think that's sensible

MEGAN MCARDLE: In hindsight, we can tell a comprehensible story about what happened . . .
but that doesn't really give us the "why."
Investment banks have collapsed before in the midst of bubbly markets in new, high leverage debt instruments.
Drexel Burnham leaps immediately to mind
But the whole financial system retrenches without collapsing.

RYAN AVENT: Well, one key, I think, is that every Tom, Dick, and Harry was borrowing to speculate, essentially, in the housing market
Which reminds us of the stock market pre-Depression

MEGAN MCARDLE: Actually, believe it or not, the number of people in the stock market wasn't that large.
Certainly not anything like the numbers who were speculating in housing in 2006

RYAN AVENT: Are you telling me the speculating bellhop is apocryphal?

MEGAN MCARDLE: Not exactly

RYAN AVENT: Because that would be disappointing

But most people on Main Street wouldn't have been trading stock.
Certainly nothing like the numbers who were involved in the housing market.
The stock market's primary effect was on business investment and the banking system, and of course, the lifestyles of some rich people
Unfortunately, that was bad enough
But that's the same sort of mystery
You can tell a plausible story about how the stock market touched off the Great Depression
But it only REALLY works if you already know the Great Depression was going to happen

RYAN AVENT: But that story would include massive bank failures

MEGAN MCARDLE: There wasn't any particular reason, in an era dominated by debt finance--

RYAN AVENT: And really bad monetary policy

MEGAN MCARDLE: ...that industrial demand should have fallen as spectacularly as it did.
I find even the Milton Friedman thesis curiously unsatisfying these days
If you read him, or Bernanke, or any of the other greats, what you start to notice is these really fairly big holes that are glossed over.
Friedman, for example, notes that "It's not entirely clear why the second banking crisis happened" (I paraphrase from memory)
And then marches briskly onto the next thing


MEGAN MCARDLE: Bernanke says much the same thing about the secular collapse in consumer demand in 1930
Well, two years ago, I would have happily nodded along
Indeed, I did
Suddenly, I'm rereading and saying, "Wait a minute! These are pretty much the crucial questions we need to answer!"
Are we going to have a banking crisis?
Is consumer demand going to collapse without reason?
And it turns out we NEVER knew those answers
We just thought we did
Or I thought we did, anyway
Perhaps you were more skeptical

I'm not sure that it's necessary to wrap things up in one or a few neat packages, though

MEGAN MCARDLE: Which is lucky, because I'm not sure it's possible

RYAN AVENT: No. There are a lot of stories that aren't mutually exclusive that contribute to the the Depression and this environment

MEGAN MCARDLE: I think that's a big point
The last seventy years of economics have been, if I might take a little journalistic license, the search for the Unified Field Theory of depressions.
Maybe there isn't one
Maybe you just get them when too many things go wrong at once

RYAN AVENT: It's all about the economic ether


RYAN AVENT: I mean, I think that's about right

MEGAN MCARDLE: That leads us to the next Big Question, though
Can Obama get us out of it?

RYAN AVENT: In a complex system with lots of feedbacks, if too much goes wrong you get a bad situation

MEGAN MCARDLE: Will stimulus work?

RYAN AVENT: Man, I hope so


RYAN AVENT: I have been on the yes side of this debate

MEGAN MCARDLE: What do you think of his stimulus package?

RYAN AVENT: I think it's pretty good
It's hard to know what the final thing will look like
I'm not as concerned about the initial size
I think that the next round of economic statistics may well tell us whether more is needed, and create the political environment to deliver more
If we do think this thing will continue for three years or so, then we can tailor our solutions appropriately
But it's also difficult to know how things will work out without real improvements in the financial system
And the real thunder and lightning in Obama's early days may come on that score, rather than on stimulus
Citi will become the National Bank of Obama, or some such thing
What do you think of the stimulus?
Libertarian opinion has not been particularly kind on this regard

MEGAN MCARDLE: I'm kinder to the notion of stimulus, in theory, than most libertarians
Here are my questions
1) Do we know that stimulus really does much in these situations? Most of the argument that it does rests on a couple of data points. And all those data points really indicate, in the most positive possible spin, is that stimulus works for a year and then stops working as soon as the spending stops
2) How much of the belief that stimulus "works" comes from measurement error? If you hire people to dig holes and fill them up, measured GDP increases. But actual welfare would probably have been higher if those hole-diggers and hole-fillers had been on the dole, consuming leisure
3) Where will the money come from? We certainly don't have excess savings, as Keynesian theory would seem to demand. And the foreigners who have been lending us money may need it to perform their own domestic stimulus
4) How fast can these "shovel ready" projects actually be put in? Most of the projects we really want, like high speed rail, require skilled workers, like crane operators, who aren't necessarily underemployed right now, not illegal laborers who are good with a shovel and a hammer

RYAN AVENT: Those are good questions.

MEGAN MCARDLE: 5) When does the U.S. start running into sovereign debt problems? If WWII is our model, then fiscal stimulus requires levels of spending I don't think we can borrow
6) How is the U.S. going to roll over this gargantuan quantity of short-term debt at absurdly low interest rates if the economy does recover?
I think that's it

RYAN AVENT: On 1), I think it's worth taking action simply to prevent a bad situation from becoming really bad. We do have an indication that there is some positive multiplier there, and given the probable duration of the recession and our infrastructure needs, there's a good argument for a large, sustained stimulus.
If we have things that are worth doing, we should do them, and of course the longer the time-frame, the better the projects will be.
At present we can borrow very cheaply
Which is good. And while foreign central banks are likely to stop lending to us on the scale of recent years, they'll continue to have some demand for Treasuries.
And suddenly -- too suddenly really -- we're saving again. Private saving may well finance the 2009 deficit.

MEGAN MCARDLE: Right now, my impression is that much of that saving is paying down debt

RYAN AVENT: But there is a question about how long we can sustain this kind of borrowing, I'm just not sure that the alternative—not borrowing—is anything we want to confront.

MEGAN MCARDLE: Which is just cash sitting on balance sheets
I'm not particularly worried about this year's deficit
I'm more worried that, in libertarian parlance, "There is nothing as long lived as a 'temporary' government program"
If we do bad things because we *can*, we'll be stuck with them for a long time
You and I probably disagree on this
But I don't think it desireable to have another jump of 1000 or 2000 basis points in the government share of GDP

RYAN AVENT: I don't know, I mean, there are long-run budget issues.
The question is, how hard is it going to be to address them?

MEGAN MCARDLE: Well, we've known for at least ten years that we were facing a major Medicare crisis

RYAN AVENT: That's the big one.

MEGAN MCARDLE: So far the legislative response has been—massive new spending

RYAN AVENT: Politicians have a tough time saying no

MEGAN MCARDLE: They have a harder time saying no when they are cutting an existing benefit -- in part, for the fair reason that people come to depend on those benefits
It may not be fair that some guy in Iowa gets paid not to grow corn on his acreage, but as of now, that's an integral part of his fiscal strategy

RYAN AVENT: But health spending is going to rise in any case. If the rise takes place on the government balance sheet, but it's a smaller total rise, then perhaps we're not in such bad shape.

MEGAN MCARDLE: And if you cut the benefit, you not only take away a big part of his income, but sharply reduce the value of his major asset, the farmland
Similarly, we don't know what market alternatives might have arisen to Medicare
But now there aren't any, which means if you cut it at all, you devastate either seniors or doctors, or both

RYAN AVENT: No, but we can see what other countries are doing, and how much they're spending, with what effects

MEGAN MCARDLE: As I say though, it's much easier to not spend the money in the first place then to stop spending it
Doctors in other countries make much less than here, as do other health care workers down the chain
It's one thing to restrain someone's salary, it's another to tell him that he now can't pay his mortgage
And seniors are used to a lot of treatment
In other countries, they aren't used to being able to, say, see a doctor once a week if it strikes their fancy
They never could, so they don't miss it

RYAN AVENT: Well, let's step back a moment
Greg Mankiw has written several times in criticism of Rahm's statement that the crisis presents an opportunity (paraphrasing)
He suggests that this points to a Democratic desire to permanently increase the size of government
But just as possibly, it could be that the crisis will provide the opportunity to make some of these hard decisions


RYAN AVENT: Is that Obama's plan?
I don't know

MEGAN MCARDLE: But I will say that I don't think it's apocryphal that the Democrats view this as a historic opportunity to spend more, permanently
We just had a big article on it -- and Josh Green is not exactly a wild-eyed conservative.

RYAN AVENT: Spend more, or differently?

More programs
They're not looking for opportunities to cut spending
They view it as an opportunity to pass their wish list under the guise of stimulus
And the belief that small-government conservatism has been discredited

RYAN AVENT: This view is not unique to our representatives
I believe it's popular in the electorate
Which is how they all got there

But the electorate is not, by and large, under the impression that a failure of financial regulation directly translates into universal healthcare.
Our representatives seem to be

RYAN AVENT: I don't think that's the case
I think it's easy to see, for instance, how the current failures of our social safety net have made the recession more painful

MEGAN MCARDLE: Look, I'm sure that there are small-government conservatives who do view this as an opportunity to get some items on their ideological wish list (though I think they're bloody-well deluded)
But I don't think it's in question that Democrats are finding that the financial crisis calls for—pretty much exactly what they already wanted to do

RYAN AVENT: But if one were to think that what they wanted to do was largely good policy, then that's ok, right?

MEGAN MCARDLE: Note that the tax cuts, which are pretty much the quickest way except certain fiscal stabilizers to get money out there, are probably going to be trimmed back because of congressional opposition

RYAN AVENT: Some of them, and based, I think, on valid concerns about their potential effect

MEGAN MCARDLE: Just as the small-government conservatives think their agenda is good policy
But no one's idea of good policy is very much related to the actual events
I myself am definitely in favor of things like extended unemployment benefits and other automatic-or-not safety net things designed to ease the problems
of a contracting economy
I am almost ready to sign onto a WPA-type deal
But I'm no fonder of universal health care than I was six months ago

RYAN AVENT: I think some of the things Obama is looking to include in the plan might not necessarily address the immediate crisis (except for their stimulative value) but are closely related to the issues that got us into this mess

MEGAN MCARDLE: At any rate, I wasn't trying to get into a debate about which side had purer or better motives
More to say that I don't think the crisis makes it any more likely that we're going to deal with our giant entitlement program problem
I think it's likelier to go in the other direction -- more projects that last a long, long time, though I don't know what the modern equivalent of the TVA is
The troubling thing is that I think in some ways Obama has a much harder problem than FDR
Better economic knowledge, to be sure

RYAN AVENT: I guess I'd just say that a lot of things contributed to the current mess, but Social Security wasn't one of them

MEGAN MCARDLE: (Thank God there will be no NRA)
I don't think it did
I just don't think we'll fix it, either
And it does need to be fixed, less because of the cost, than because of the loss to the economy represented by 80% of the over-65 set not working
And Medicare, even more so, both because of the cost, and because its structure is a horrifying anachronism that costs more and delivers less than it should

RYAN AVENT: Let me ask you this--
if we see continued deterioration in economic datapoints, does that make Republicans in Congress more likely to cooperate with Obama, or does it galvanize the opposition?

MEGAN MCARDLE: That depends on how long the deterioration lasts
I tend to agree with other pundits that Obama has about eighteen months of free pass, during which it can all be blamed on Bush
But if the economy hasn't improved by midterms, the Democrats are very likely to lose both houses
If, like me, you're essentially a pessimist who doubts the government can do much in the teeth of these things other than alleviate the pain, then what you need to know is whether we're in 1932 (as many jubilant lefty twitters proclaimed on election night), or 1930
If the former, Republicans will shape up and go along
If the latter, they'll get more intransigent and kill at the polls

RYAN AVENT: Well, unless we're on an accelerated time scale, we're in 1930.

MEGAN MCARDLE: Then Obama had better hope hard that I'm wrong and stimulus is very effective
Or that this thing isn't as bad as it looks right now
Neither would surprise me

RYAN AVENT: You know, for whatever reason I'm a little more optimistic than I was a few weeks ago
I think part of it has to do with the fact that credit markets are coming unglued
And part of it is that we survived the interregnum
It's interesting to go back and look at data from late August
It actually looked pretty decent
It's hard to know how much damage has been done thanks to the financial collapse

MEGAN MCARDLE: There are two views, I think
There's the view that we had a short, sharp, panic, and will now have to live with lower growth, but survive
Then there's the, "It's not quite clear what led to the second banking panic . . . ", which haunts my sleepless nights


MEGAN MCARDLE: One candidate: Option ARMS. We're in a lull right now
The subprimes have already mostly reset. But the option ARM swell is due to start later in the year and peak in 2010.

RYAN AVENT: It's also interesting to read magazine archives from 1930. Suffice it to say, they thought a turnaround wasn't too far off

MEGAN MCARDLE: So, the housing market
Bottomed, or not?
You're a homeowner, right?

I'm the guy who bought high, and who would now like to sell low
My hope is that we'll begin to see some markets recover


RYAN AVENT: That's what we were seeing in August

MEGAN MCARDLE: When did you buy?


Although, at least DC has secular gentrification

RYAN AVENT: Right, there are worse places I could have bought

MEGAN MCARDLE: It's amazing how much the DC market was affected by the bubble
As you may know, I just moved

RYAN AVENT: I saw that

MEGAN MCARDLE: We finally settled at 9th & Florida, but we wanted Bloomingdale
The weird thing is that Bloomingdale was bubblier than U Street in rents
Tiny little houses supposed to rent for $2500 a month

RYAN AVENT: Interesting
A nice area, but there's not much there at the moment

MEGAN MCARDLE: People are clearly pricing to their overpriced mortgage payments
Not the market demand

RYAN AVENT: People will tell you that the rental market here remains hot, though

MEGAN MCARDLE: Most properties are well priced
But in the bubbliest areas, like Bloomingdale, which still doesn't have the services to support high rents, there's a lot lingering on the market

RYAN AVENT: Of course, Washington also has the lowest unemployment of any metropolitan area in the country

MEGAN MCARDLE: The house next to mine was just repriced from $500,000 to $350,000
You and I have a clear conflict of interest: I want to buy in a couple of years, so I'd like it to fall further
But alas I fear you're right

RYAN AVENT: You probably have 12 more months of falling prices, at least

MEGAN MCARDLE: The rest of the country, however
What do you see happening?

RYAN AVENT: It looks very bad
Particularly now that some places are also seeing falling rents
And commercial real estate defaults are piling up in some local markets
Now, the bright side in places with lots of foreclosures, is that bank sales are so dirt cheap that some buyers are coming back into the market
But a lot of areas are just plain old overbuilt

MEGAN MCARDLE: I think that's the key here
There's simply an overhang of housing inventory that is going to take years to absorb
As Arnold Kling has repeatedly pointed out

RYAN AVENT: It's a wonder to me that the fallout in some of these areas, economically, hasn't been worse
And maybe on the ground it looks different
But you have whole areas in California where whole neighborhoods are empty
I don't know how the local governments haven't just shut down
And left the city to become a ghost town

MEGAN MCARDLE: It looks like some of them may have to
Have you been following the pensions crisis?


MEGAN MCARDLE: CalPERS lost a mint in real estate, among other things
Pension contributions are going to go way, way up for local governments

RYAN AVENT: We can tie this back to our entitlement discussion
What are you doing with your retirement?
Do you still have faith in 401(k)s?

MEGAN MCARDLE: I think all three possible retirement options have massive problems
401(k)s are problematic because individuals have a hard time bearing catastrophic risk
Governments set up systems with very bad incentives and don't control costs
And companies are prone to failing
If I had my druthers, I'd set up a system that combined forced savings with a guaranteed minimum retirement income
Something like Chile or Sweden


MEGAN MCARDLE: Social Security is far too generous and comprehensive
But I don't think that you can simply leave people entirely on their own
I feel the same way about Medicare: to the extent it's needed, it should be part of Medicaid
Providing care for the truly indigent, not subsidizing greens fees and visits to the grandkids
But this is a very unpopular view

RYAN AVENT: Especially among retirees

MEGAN MCARDLE: And has approximately the same chance of being enacted as my plan to subsidize female economics journalists over 6 feet tall

RYAN AVENT: And especially now
So long as there's gender equality

MEGAN MCARDLE: Ah, coalition building! Perhaps we could log-roll a bit with the vertically challenged sportswriters

RYAN AVENT: I think the long-term societal effect of this crisis is going to be significant

MEGAN MCARDLE: Undoubtedly
But in what way, specifically?
Do we end up with more government, less government, or different government?

RYAN AVENT: Well, I think you're going to see major changes in investment behavior
More government, previous arguments notwithstanding
I think you're going to see major changes in familial structures, as boomers struggle to retire
The return of the three generation household
Things of this severity linger, though
Perhaps a long-term shift in the relationship between state and federal government
Better novels?
Who knows?
But I can already detect changes in my long-term expectations, and priorities


RYAN AVENT: Most folks under the age of 50 had no idea what a bigtime downturn was going to be like
I'm more risk averse
Discussing professional decisions with my wife, it's clear that we're much more concerned about not exposing ourselves to disaster

I'm much more concerned with paying down debt—even low-interest debt, like my ridiculously underpiced student loans
Building up an enormous reserve fund

RYAN AVENT: Enormous, eh?

MEGAN MCARDLE: Well, enough to live on for a year
The two-journalist couple is one of those foolish financial decisions you can't help making

RYAN AVENT: Not much better than the journalist-public teacher couple

MEGAN MCARDLE: I think over the next year, you're going to see a lot more home entertaining, a lot less dining out and drinking out

RYAN AVENT: I'd say I should have followed my classmates into investment banking, but that doesn't seem quite right



MEGAN MCARDLE: A lot less travel
One of the things you notice in the 1930s is the ads aimed at middle class women who are obviously learning to entertain without servants

RYAN AVENT: Yes, it broke our heart to fire Jeeves
But I think you're right

MEGAN MCARDLE: My favorite is the Toastmaster series on "make your own toast" parties
Because if there's one thing that entertains guests, it's toasting their own bread before spreading on the potted meat
The theater crashed and the movies took off
I'd bet the video game industry actually does very well out of the recession
Especially the Wii

RYAN AVENT: I do love my Wii

MEGAN MCARDLE: We should play online!

RYAN AVENT: We should, I'm really good at Mariokart
Another question concerns the geopolitical fallout
Last time we had a Depression, the international scene changed quite a bit, and not for the best
Do you think there's a risk of catastrophic political collapse in, say, China?
Growing unemployment there does not bode well

MEGAN MCARDLE: I think China is a big unanswered question
No one knows if they can grow slower, or if a hiccup will cause the whole thing to melt down either economically or politically
They need to create something like 20 million new jobs a year to prevent civil unrest
A bad sign is that people from the cities seem to be moving back to the countryside for the first time in a generation

I guess one question is how far the government will go to protect output and exports

MEGAN MCARDLE: How far can they go?
They could be selling televisions for $100, and my household would still pass it up in favor of savings
Or at least, putting in real dining-room chairs
Well, maybe not $100
I AM living with a film critic
But we were not tempted even by the deep holiday discounts

RYAN AVENT: What do you build when no one wants to buy any of your stuff anymore?

MEGAN MCARDLE: China needs to build up domestic demand
And I'm not sure how that's going to work

RYAN AVENT: I agree, but it's hard to do that with rising unemployment
Unless they just start cutting big checks to Chinese families
Which, actually, would be nice

MEGAN MCARDLE: Russia and Iran are possibly even more worrying problems
China doesn't have a good target for a chest-beating invasion to deflect their domestic economic woes
Though I suppose I wouldn't buy real estate in Taiwan right now
But Russia and Iran are both suffering mightily from falling commodity prices, and both have a history of local imperialism

We could look elsewhere, too
Things begin to look much scarier when the global pie is no longer increasing
That seems like a positive note on which to end, no?

MEGAN MCARDLE: Well, let's find a positive note
What good came out of the thirties?


MEGAN MCARDLE: Shirley Temple movies?

RYAN AVENT: Fitzgerald?

MEGAN MCARDLE: He was washed up by the thirties
The Jazz Age was his era
Actually, I'd say there were a number of positive developments in the 1930s
The movie musical

RYAN AVENT: Which has been enjoying a resurgence

MEGAN MCARDLE: Many of the labor-saving home devices we now enjoy
(As a developed medium)
Commercial aviation
Help me out here . . .

RYAN AVENT: Um, the social safety net?
It wasn't a very pleasant decade

MEGAN MCARDLE: Really fun little hats!

RYAN AVENT: Eleanor Roosevelt!

MEGAN MCARDLE: I suppose the best we can hope for is this:
People rebuild their savings and learn to entertain themselves with stronger ties to friends and family

RYAN AVENT: And hopefully don't try to conquer Europe

Any readers who are planning to conquer Europe should stop that right now
Particularly if they are bad pop musicians
On that note, we should probably end this dialogue
And get back to increasing GDP

RYAN AVENT: Maybe this time next year, we'll be chatting about the depression that wasn't

MEGAN MCARDLE:From your lips to God's ears