Simon Johnson: This Could Be The ’70s All Over Again… The 1870s!

1870s panic

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For your super-gloomy reading of the day, check out Simon Johnson at Baseline Scenario who asks: “This A Second Great Depression – Or Could It Become Something Worse?”See, there’s been a lot of this ultra-gloomy rhetoric lately about the market lately, but what’s really getting people worked up is the combination between the bad economic situation and the rise of the Tea Party in Washington DC, and what that means for economic policy.

The inability to do any counter-cyclical action — first through the GOP Congress, and now through threats on Fed easing — is what makes the situation so dramatic.

Says Simon Johnson:

The rise of the tea party has taken fiscal policy off the table as a potential counter-cyclical instrument; the next fiscal moves will be contractionary (probably more spending cuts), irrespective of whether jobs start to come back or not.  In this situation, monetary policy matters a great deal – and Mr. Bernanke’s focus on avoiding deflation and hence limiting the problems for debtors does not seem inappropriate (for more on Mr. Bernanke, his motivations and actions, see David Wessel’s book, In Fed We Trust).

Mr. Bernanke has his flaws, to be sure.  Under his leadership, the Fed has been reluctant to take on regulatory issues – continuing to see the incentive distortions of “too big to fail” banks as somehow separate from monetary policy, its primary concern.  And his team has consistently pushed for capital requirements that are too low relative to the shocks we now face.

And the Federal Reserve itself is to blame for some of the damage to its reputation – although it did get a major assist from Treasury in 2008-09.  There were too many bailouts rushed over weekends, with terms that were too generous to incumbent management and not sufficiently advantageous to the public purse.

But to accuse Mr. Bernanke of treason for worrying about deflation is worse than dangerous politics.  It risks returning us to the long slump of the late 1870s.

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