Economy: Lost Decade?

I'll admit that after Obama's election, I mostly sat back and let his administration do their work. I didn't think too hard about whether they were getting things right. Only now that some of their plans - most notably on the economy - am I really trying to understand what went wrong and why.

The person I have been looking to the most is Paul Krugman, but I have lately been expanding my horizons to see what the right thinks (mainly through WSJ and Financial Times). It seems to me that almost everyone agrees the government should do something to help the economy - whether it be through monetary or fiscal policy. Unfortunately, it seems that monetary policy is not very useful at the moment as interest rates are up against the lower bound (ie cannot go lower than zero and are near zero now).

That leaves fiscal policy. As we know however, there is no public support for fiscal stimulus and there are no leaders willing to try to change minds and convince people that fiscal stimulus is necessary. Bernake is unwilling, as is Obama.

I will admit, as Obama should, that the original fiscal stimulus was imperfect - and not only because it was too small. Shovel-ready didn't pan out as planned and Davis-Bacon requirements slowed things down. Plus, the stimulus seemed to replace state and local spending cuts, negating the stimulus effect.

I had assumed it was common knowledge that we got out of the Great Depression with stimulus spending - ie the war - but there seem to be many that think otherwise and are doing a good job of convincing the public of that. (And if you wonder why war spending is a better stimulus, I would argue that it is because we mobilize war spending very quickly and rarely argue about whether it is too much spending or too little so long as the cause is just.)

If I am understanding the Wall Street Journal and Financial Times correctly, they also think that fiscal policy might help but is politically not viable and monetary policy (QE2 - ie Fed will buy long term debt instead of short term debt) will be mostly ineffective.

Only non-economists are saying that less government spending will allow businesses to spend more and that will get us out of the recession. This isn't the answer because businesses are facing surpluses of their products, and only consumer spending will clear those surpluses and cause businesses to re-start production and hire again. Fiscal stimulus is our only way to achieve that.

If fiscal stimulus is a no-go and monetary policy will not be helpful, what is the outcome? Unfortunately, probably a lost decade.