And now, the bill arrives: recession

Robert Kuttner

November 30, 1990|By Robert Kuttner

THE DUBIOUS honor of officially declaring the economy in recession used to belong to the National Bureau of Economic Research, a venerable, official-sounding private institute based in Cambridge, Mass. NBER's arbitrary definition two consecutive quarters of decline in economic output had the virtue of being precise and intuitively approriate.

By that test, we are not quite in recession yet. But last Tuesday, the upstart National Association of Business Economists jumped the gun and declared a recession on the basis of a far softer, but more contemporary, indicator a poll! Three-quarters of its members polled think the economy is in recession, so a recession it must be.

Whenever this recession actually began or begins it promises to be different from others of recent memory, and far trickier to transcend.

In the first place, we begin this recession with a huge federal budget deficit. Normally, deficits are what governments use to get out of recessions.

In the second place, we begin it heavily in debt to foreign lenders. That makes it much harder for the Federal Reserve to TC use cheap money to coax the economy out of recession. For if interest rates go too low, the dollar loses even more of its value and foreigners stop lending us money.

Third, banks are substantially shakier than on the eve of an average recession. They are already under heavy pressure from regulators to clean up their balance sheets. That, in turn, has led to a tightening of credit standards, squeezing small businesses and home-buyers and helping trigger the very recession that will leave banks that much worse off.

What to do?

In conventional economic policy-making, there are two basic, if opposite, courses the government could pursue. The first is the one we have been hearing about for a decade: Cut the deficit, reduce consumption, increase savings rates and hope that the ensuing gains in productivity and competitiveness will power a gradual and long-term recovery.

The trouble with this approach is that, once in a recession, you can't deflate your way out of recession. A smaller deficit an reduced consumption may reassure the money markets and eventually lead to more investment, but it will push the real economy that much deeper into a slump for the time being.

Alternatively, the government could decide that a dose of inflation is better than a deep recession. (It may do this anyway, inadvertently, through the stimulative effect of a Persian Gulf war.)

A program of economic stimulus, even if inflationary, would have several distinct benefits. It would put people back to work and prevent a further plunge in purchasing power.

Moreover, in times of inflation, money pours back into real assets. A dose of inflation would be very tonic for the flat real-estate market: Real estate would suddenly look like a safe haven. And since the sagging real-estate market is substantially responsible for the banks' woes, rising property values would also help rescue the banks.

While there is no painless cure for excess debt, inflating our way out of debt is the most politically expedient. Gradually, the debt becomes less fearsome in relation to the real economy, which doesn't have to suffer the pain of a deep contraction. Moreover, unlike in the 1970s, the economy is less riddled with cost-of-living clauses. Mild inflation would probably not become as stubbornly embedded as it did then.

However, in the dismal science of economics, almost every benefit has an offsetting cost. With inflation, people on fixed incomes suffer. Creditors lose out. (That's not so bad; creditors in general are richer than debtors.)

But more seriously, once inflation takes off it is hard to restrain. Inflation tends to clobber the stock and bond markets. Foreign creditors would begin demanding astronomical interest rates in order to keep investing in dollars that were losing their relative value.

A rather different approach, not currently on the menu, would be to seek the same kind of stimulative benefits you get from a war, without suffering an actual war. This strategy would substantially increase taxes on the well-to-do and power a recovery through public investment. That, however, would require a tolerance for higher levels of taxation and public spending than are currently fashionable something Americans rarely accept graciously in the absence of a national emergency.

In short, there will be no painless cure for this recession only a rather unpalatable choice of different kinds of pain.

Nonetheless, it is very important to appreciate that we do have choices, and that each has political and distributive implications. An austerity cure would produce one set of winners and losers. An inflation cure would produce a rather different set. A public-investment cure would mean a still different mix of gains and losses, as well as markedly different politics.

The lessons we choose to draw are as important as the policies we choose to pursue. One lesson, surely, must be that Reaganomics was no free lunch. And now, the bill.

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