Tuesday, September 01, 2009

Allan Meltzer: What Happened to the 'Depression'?

Allan Meltzer,  professor of economics at Carnegie Mellon University, had a good opinion piece in The Wall Street Journal yesterday entitled "What Happened to the 'Depression'? - Despite the rhetoric from Washington, we were never close to 25% unemployment" in which he debunks the comparisons of the current recession to The Great Depression. He asks "So why do many opinion makers insist on inaccurate and frightening analogies that overstate the severity of present conditions?" and then proceeds to point out the many political benefits of such a comparison, with similar benefits for many economists and the media.

Prof. Meltzer also takes the time to point out a fact that I knew but never shows up in the media: The Great Depression consisted of two recessions, from 1929 to 1932 and from 1937 to 1938.

The most significant point that I think Prof. Meltzer makes is that it was a huge mistake for the Federal Reserve to stand by and let Lehman Brother fail. As he says, "Allowing Lehman to fail without warning is one of the worst blunders in Federal Reserve history." By the way, Prof. Meltzer has written the definitive history of the Federal Reserve. Prof. Meltzer tells us that "After 30 years of bailing out almost all large financial firms, the Fed made the horrendous mistake of changing its policy in the midst of a recession. That set off a scramble for liquidity and heightened the public's distrust in the market." And, as they say, the rest is history.

The good professor closes with his own prescription:

A sensible administration would revise its policy. It should start by scrapping what remains of the stimulus. As the world economy recovers, the United States should choose to expand its exports so that it can service its large and growing foreign debts. That means reducing corporate tax rates to increase investment. Instead of implementing policies that increase regulation and raise business costs, we need to increase productivity. And the Fed should soon begin to reduce the massive volume of outstanding bank reserves, which is the raw material for future money growth.

Prof. Meltzer certainly knows his stuff, but there are always more ways than one to skin a cat. The administration's approach may be rather sub-optimal and in a state of flux and Prof. Meltzer's prescription may be distinctly superior, at least in the abstract, but that is not to say that the administration's approach is strictly doomed to either fail or necessarily even to dramatically underperform compared to Prof. Meltzer's approach.

-- Jack Krupansky

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