Former Texas Sen. Phil Gramm got in trouble when he said Americans are mired not in an economic contraction but in a "mental recession." He soon had to step down as co-chairman of Sen. John McCain's campaign for committing the ultimate political sin: telling the truth about a misperception that happens to be very popular.
Americans feel as though the economy is in a recession and want the government to do something about it. In reality, it is expanding. In the second quarter, it grew at a respectable inflation-adjusted rate of 1.9 percent, double the pace of the first quarter. Unemployment was up, but it's still a pretty mild 5.7 percent.
The recession cures being bandied about by the presidential candidates and others miss the real source of our pain and what can be done about it - which is not much.
"There's a great misunderstanding of what's happened," says economist Allan Meltzer. The main trouble, in his view, is not that Americans are suffering from weak or negative economic growth, but that they have suffered a loss of wealth, a very different ailment. He explains that the loss stems from two major factors. The first is high oil prices, which are the equivalent of a huge tax increase. The second is the housing bust, which has vaporized more than a trillion dollars worth of assets.
What does all this mean? Our standard of living has declined. We can't afford all the things we used to, because so much of our income is going to pay for gas.
In the past, we might have cashed in our rising home equity to keep consuming at the same rate as before, but you can't do that when your home equity is shrinking. Plus, we are under pressure to save more, since we can't count on real estate profits to finance a comfortable retirement.
When the economy contracts, the government may use sound monetary and fiscal policy to help revive growth. But when wealth goes up in smoke, the government can't necessarily bring it back. If it tries, the effect is likely to resemble what happens when you give a recovering alcoholic a drink: deceptively pleasant at first, but ultimately calamitous.
In the 1970s, the Federal Reserve reacted to soaring oil prices by creating more money and spreading it around. When you have more money, it doesn't hurt so much to fill your tank. But when everyone suddenly finds themselves with more money, the consequence is inflation. In the 1970s, instead of seeing just the price of gas climb, we saw the price of everything climb.
