The Second Great Contraction

The American economist, Kenneth Rogoff, suggested this week that we stop referring to our present economic woes as The Great Recession, and instead label the present situation The Second Great Contraction. The first Great Contraction occurred in the 1930's. The same thing is happening again.

The problem with our present terminology, Rogoff writes, is that it assumes that our present situation is just another -- somewhat tougher -- garden variety recession, a notion which "is predicated on a dangerous misdiagnosis of the problems that confront the United States and other countries, leading to bad forecasts and bad policy."

The market gyrations of the past week were certainly a reaction to bad forecasting. The debt deal which was reached in Washington is an egregious example of bad policy. The real problem, Rogoff maintains, is that policy makers have not truly understood how bad the situation is:

The real problem is that the global economy is badly overleveraged, and there’s no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression or inflation.

During the First Great Contraction, Franklin Roosevelt's New Deal transferred wealth from creditors to debtors. Economists like Paul Krugman and Robert Reich argue that the same kind of response is required now. They argue for a new Works Progress Administration and a new Civilian Conservation Corps. The need for infrastructure improvement is everywhere -- from bridges that fall into the Mississippi River to huge slabs of concrete which fall onto Montreal's freeways. We live in an age -- in John Kenneth Galbraith's phrase -- of "private wealth and public squalor."

But what the debt ceiling debate underscored  (yet again) was our political and power elites' absolute failure to come to grips with the real problem. And, until they change or are replaced, there will be no large scale public works programs.

In the light of that failure, Rogoff asks, "Is there any alternative to years of political gyrations and alternatives?" -- and then he answers his own question:

I have argued that the only practical way to shorten the coming period of deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4 per cent to 6 per cent for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But such a transfer is the most direct approach to faster recovery. Eventually, it will take place one way or another, as Europe is painfully learning.

Rogoff's suggestion will drive lots of policy makers crazy -- because it's difficult to keep inflation "moderate."  But, at the moment, those who hold the reins of power are not listening to Krugman, Reich or Rogoff. And, in the meantime, wealth remains in the hands of the creditors and hope drains away from the debtors.


This entry is cross posted at The Moderate Voice.