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Three Very Smart Economists Being Very Gloomy About America's Foolish Choices

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The CBPP has the transcript of the very nice "Economists Panel: Budget Policy, Short-Term Recovery and Long-Term Growth" at the America's Fiscal Choices symposium. Jackie Calmes, Martin Feldstein, Jan Hatzius, and Paul Krugman.

The only thing wrong with the transcript is that it keeps saying "Marty Feldman" instead of "Marty Feldstein":

"Hump? What hump?" "Never mind..."

Panel 2: Economists Panel: Budget Policy, Short-Term Recovery and Long-Term Growth

9:30 am – 10:30 am

CALMES: I thought I'd... ask each of our panelists what they see as the trajectory for unemployment through the end of 2011, and when we might start to see something approximating full employment, and what do we need to do to get there. So, with that small little question, I'm going to start with Paul.

KRUGMAN: OK. So on the first half of that question, I only know what Jan tells me.... [W]e're looking for rising unemployment over at least the next few months.... I would have guessed that we probably see unemployment continuing to rise, right up to the end [of 2011].... And as for when we return to something that looks like full employment, I think the maximum likelihood estimate is, basically, never.... [T]here's nothing visible on the horizon that will cause that to happen... no policy... aiming at returning to full employment... no technology that will drive a large amount of business investment. Historically, [in] the aftermath [of large] financial crises countries recover by having a huge exchange rate depreciation, which then leads to an export boom, but since it's basically the whole advanced world that's caught up in this, and there aren't any other planets to export to, that's not going to happen....

[T]he last time we had a global financial crisis, the recovery to full employment was accomplished by a coordinated, large fiscal expansion, known as World War II.... [W]e ought to be doing everything you can. We ought to be having quantitative easing, we ought to be having another round of stimulus.... [Y]ou'd have to have... stimulus big enough to bring capacity utilization back up to a high enough level that business investment really starts going again....

CALMES: Marty?

FELDSTEIN: I don't think Paul and I disagree all that much about the outlook. Certainly about the short term... it's pretty bleak. We have a GDP gap now which is roughly a trillion dollars, that's why we have almost 10 percent unemployment, and the GDP gap was almost as large at the beginning of 2009, and the fiscal stimulus package wasn't close to big enough to fill that hole.... [Y]ou had a whole which was, roughly, $800 billion dollars and they tried to fill it with a $300 billion, $400 billion annual fiscal injection.... [WE]e never got lift off, we never got into a recovery. And various temporary measures that we had, the cash for clunkers, the first-time homebuyers, they're finished.... The rest of the world is not going to help. The dollar relative to the rest of the world is not going to help....

KRUGMAN: [R]egardless of whether the Democrats somehow cling to the House, we're almost certainly heading for political paralysis.... I agree with Jan that there are two main scenarios, one of which is pretty bad and one of which is very bad. But there's probably a third one, which is absolutely catastrophic....

FELDSTEIN: So what can be done? So one thing that can be done is to work on fixing the situation for owner-occupied housing, fixing the mortgage situation. None of these are guaranteed to fill a trillion dollar hole, but they move you in the right direction. If house prices are beginning to go up, consumers are going to have more confidence. They're going to spend more.... Another thing that can be done is to deal with the problem that was just mentioned and that is the commercial real estate.... You don't hear so much about it, but, again, commercial real estate prices are off from the peak by about 40 percent. A lot of that is financed on five-year balloon loans that will start to come due 2011, 2012.... One could go in and work on the capital effects of fixing the impaired loans, impaired commercial real estate loans on the books of these thousands of small banks that we have around the country....

HATZIUS: I think [the] Federal Reserve is definitely an institution to talk about. They are going to do more... it's very likely to come at the next FOMC meeting, the day after the mid-term election.... I think it'll have some effect, but... the numbers that are required to really move the needle a lot are very, very large. And I think there's going to be a natural bias towards caution on more monetary policy makers in this sort of environment. I think that's usually what happens when you're in a liquidity trap, you're at the zero bond for short- term interest rates. You send the staffers away and ask them, you know, try to figure out what's the optimal policy here, and they go away, and they model things, and they come back with some, you know, enormously large number for the amount that needs to be purchased, and the policy makers say, "Oh, you know, are you really sure that you've taken account properly of all the tail risks that are associated with this? I mean, are your models going to be able to pick up the tail risk that, you know, maybe people are going to lose confidence, the financial markets in some diffuse sense are going to lose confidence." And so, policy makers say, you know, what you are saying makes some sense, let's take a small step in that direction. And that's why, I think, in this type of situation, stimulus tends to be, basically, underprovided, relative to what's necessary. And I suspect that that's what we're going to find again....

KRUGMAN: And then there's the trap, the same thing, I think in a milder form, that happened with fiscal stimulus. You do something which is in the right direction, but inadequate. And then people say, "Well, that didn't work."

CALMES: Right.

KRUGMAN: And so instead of increasing the dosage until you get it right, you just -- you give up on the thing altogether... all of this is very familiar, if you... study Japan in the '90s....

FELDSTEIN: Let see if we can find something that might happen that might move us out of this. We saw the Euro fall from 160 to about 120, very quickly. What happens if the U.S. experiences a comparable fall on a trade weighted basis, a 25 percent fall in the value of the dollar?

KRUGMAN: Yes.

FELDSTEIN: That would certainly give a jolt.... [T]he world may, having looked at the problems in the U.S. and elsewhere may say, gosh... the fiscal deficits are enormous.... So if the world looks at all of that, and says, these guys are in trouble, "Why are we holding so many dollars? Why are we continuing to invest in dollar securities?" one of the effects could be a very substantial fall in the dollar. I'm not predicting it, I'm not wishing for it, I'm just saying that if that happened, that would be one of the ways out of this.

KRUGMAN: The problem is that, that leaving aside the renminbi issue, which is something I, obviously, write about, the other currencies against which the dollar would have to fall, are the euro and the yen, and we really are talking about a race between the halt, the lame and the blind here, right? So it is a little hard to tell that story....

HATZIUS: [I]f it happens quickly, then it probably would coincide with instability in... financial markets, so you would probably lose... on [the impact of financial turmoil on] economic activity what you'd gain on the currency side. If it happens more gradually, then, yes, I think it would be helpful, and it wouldn't be as helpful as it was in other countries that went through... large credit boom/busts that were ultimately followed by big currency depreciation.... [T]he U.S. only exports 10 percent of its GDP, so it's not Korea, or Sweden in the 1990s....

FELDSTEIN: And it's not just exports, it's net exports, so if exports go up a bit, and imports come down a bit because foreign goods become more expensive, so American's spend their money buying services here in the United States, that moves the trade balance by 2 percent of GDP. That's a big deal, because as you said, that's what fiscal policy -- that's what we may be losing in the fiscal policy. That's what we need to start bringing down the unemployment rate...

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