Brad DeLong says that he and everyone he knows were taken aback by our government's inability to prevent the financial crisis from turning into a protracted recession:
In order to have successfully predicted that we would be where we are now, you would have to have predicted a large number of things:
Get all of those 10 right, and you are a wizard.
- That a global savings glut and a period of low interest rates would produce a housing boom.
- That the housing boom would turn into a housing bubble.
- That the housing bubble would lead to a collapse of mortgage underwriting standards.
- That risk management practices on Wall Street would have been nonexistent.
- That the Federal Reserve would not be able to construct its usual firewall between finance and the real economy.
- That the Federal Reserve would not feel itself empowered to take the emergency steps to stabilize demand needed during and in the immediate aftermath of the financial crisis.
- That the incoming Obama administration would come out of the gate with too small an economic recovery package.
- That politics would prevent the Obama administration from being able to take a second bite at the apple.
- That the Obama administration would then give up on pushing the envelope of its powers to try to generate a strong recovery.
- That the intellectual victory of Keynesian approaches on the level of reality--forecasting and accounting for the course of the Little Depression--would be accompanied by a non-intellectual defeat of Keynesian approaches on the level of politics.
But I know of nobody who did.
The smart people I know--there imagination failed after number five or so.
Numbers 5-10 on this list deal with the inability of the American government to enact effective countercyclical policy. I have to say that I am not surprised by this at all...and I think that even without the benefit of hindsight, I would not have been surprised (and indeed, I always believed that the government's response would be inadequate). Why? Because we've never really implemented effective countercyclical policy in the past!
First, take the Fed's ability to construct its "usual firewall" between finance and the real economy. What usual firewall? Can you name a systemic financial crisis in our history that was not followed by a protracted economic slump? I am not sure I can. (Caveat: this does not establish that financial crises cause recessions, though I happen to believe that they do.) I suppose the Panic of 1907, but there was no Fed then. Maybe the LTCM collapse?
Now take the Fed's inability/refusal to stabilize nominal GDP growth after the crisis. At the zero lower bound, Fed action pretty much means QE. And when have we (or any country) ever implemented large-scale QE in the absence of out-and-out deflation? I can't think of any example.
Finally, let's consider the political feasibility of stimulus. Has the United States ever purposefully enacted a large countercyclical fiscal stimulus in the past? There's the New Deal, but as DeLong himself has mentioned, it was actually pretty small beer. Clinton's 1993 stimulus bill died a quiet death by filibuster. In fact, the only real example of fiscal stimulus that I can think of was Reagan's military buildup...but that was hardly sold as a stimulus.
So history would seem to indicate that the U.S. government is not very good at protecting the economy from financial crises or implementing countercyclical policy in really deep or prolonged slumps. I suspect, therefore, that Brad's belief in the government's abilities was really more hope than fear, and his reaction to our failure was more disgust than surprise. In other words, he was an optimist regarding the U.S. political economy. Sad to say, that is something I have never been.
Update: Mark Thoma points out that automatic stabilizers are generally politically feasible. That is certainly true.