The limits of economic policy

By Felix Salmon
July 3, 2009
Mohamed El-Erian, for one, thinks so, and he points to the unemployment rate as a key reason why things are not going to get noticeably better any time soon:

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Are the financial markets in denial about how soon the recovery will come and how impressive it will be? Mohamed El-Erian, for one, thinks so, and he points to the unemployment rate as a key reason why things are not going to get noticeably better any time soon:

The unemployment rate will increasingly disrupt an economy that, hitherto, has been influenced mainly by large-scale dislocations in the financial system.

In just 16 months, the US unemployment rate has doubled from 4.8 per cent to 9.5 per cent, a remarkable surge by virtually any modern-day metric. It is also likely that the 9.5 per cent rate understates the extent to which labour market conditions are deteriorating…

Notwithstanding its recent surge, the unemployment rate is likely to rise even further, reaching 10 per cent by the end of this year and potentially going beyond that. Indeed, the rate may not peak until 2010, in the 10.5-11 per cent range; and it will likely stay there for a while…

This possibility of a very high and persistent unemployment rate is not, as yet, part of the mainstream deliberations. Instead, the persistent domination of a “mean reversion” mindset leads to excessive optimism regarding how quickly the rate will max out, and how fast it converges back to the 5 per cent level for the Nairu (non-accelerating inflation rate of unemployment).

The US faces a material probability of both a higher Nairu (in the 7 per cent range) and, relative to recent history, a much slower convergence of the actual unemployment rate to this new level…

The combination of stubbornly high unemployment and growing government debt will not play well.

I completely agree with all of this. The markets seem to be having difficulty adjusting from a happy world where the key unemployment number is the first derivative, to the current unhappy world where the key unemployment number is the sheer deadweight number of unemployed Americans, who aren’t spending and who are going to be a major drag on economic growth for the foreseeable future.

As for the possibility of a higher Nairu, we’re so far away from there right now that for the time being such discussions are probably academic. But clearly the higher that Nairu gets, the higher the tail risk of a stagflationary spiral — and the less that policymakers can do to get us out of one. Governments managed to avert the most disastrous consequences of the financial crisis. But they might be powerless in the face of the current global economic crisis.


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“Governments managed to avert the most disastrous consequences of the financial crisis.”

You sure about this, Felix? Not jumping the gun are you?

Both El-Erian and William Gross have this Off/On Switch view of Capitalism and Society. We’ve had years of greed, now we’ll have years of fear. It reminds me of Schlesinger’s view of history. There’s some truth to these cycles, as there is to the idea of a Vital Center, but, in truth, history is quite unique and varied. As Burke said:

“History is a preceptor of prudence, not of principles.”

How and why we get out of this mess will be a matter of trial and error, and debates about it will continue on indefinitely. All that we can do is attack these problems with prudence and common sense, and focus on the task at hand. As Bagehot said:

“The great difficulty which history records is not that of the first step, but that of the second step. What is most evident is not the difficulty of getting a fixed law, but getting out of a fixed law; not of cementing (as upon a former occasion I phrased it) a cake of custom, but of breaking the cake of custom; not of making the first preservative habit, but of breaking through it, and reaching something better.”

We’ll do much better at dealing with this crisis if we take a jaundiced view of all these big picture views, especially yo-yo mechanistic ones, whether optimistic or pessimistic. If we’re optimistic, it should be because we consider ourselves resilient, not because of any one figure at any particular time.

I don’t think the market is in denial, only that it sees a bottom, but does not yet see a recovery. While there is a lot of eying and wishing going on, it is is still more fearful than optimistic.

Well, when you define economic policy as subsidizing non-bare bones housing and inefficient banks, yeah it has limits.

Posted by Phillip Huggan | Report as abusive

we live in an age of high expectations and entitlements,and if we reflect back over obama,s campaign it was all based on what the voters would receive if and when he was there is a certain level of anticipation that this was a absolute.the promise that unemployment would level out at 8%has been proven to be a pipe dream,and obama is suggesting that he meant 10%.there is a possibility that it could go as high as 13%and even higher in CA.unemployment levels like these have not had the impact in the past because of traditional families,with their support mechanism.but because of the break down of the family unit and advance of telecommunication and other mediums,it will be obvious that the hardship that these people are suffering is not uniformly spread,and we could see major social unrest break out.

Posted by brian lee | Report as abusive

COOL, obama is going to LOVE this.I DON”T the government has NEVER given me any thing I have not earned, ALL the STUFF I have is bought and paid for was with hard work that is the American Way. why can’t this nuckle head in the whitehouse see this? oh, I for got HE IS A NUCKLE HEAD!!!!!!!

Posted by nina | Report as abusive