What can we blame?

Today, Landsburg and Furman weigh possible causes of the current slump. Previously, they whether the stimulus package would work, the debt-saddled government’s ability to mitigate economic downturns, and unemployment and the mortgage crisis. They’ll conclude their debate tomorrow with a discussion on what the government should do if the stimulus package fails to prevent a recession.

Let the economy adjust
By Steven E. Landsburg

Jason:

Our assigned topic for today is, “What’s wrong with this economy?” My answer is, the same things that are always wrong with it: bloated government, a badly designed tax system and an excess of regulation.

Addressing those fundamental problems would do far more good than shuffling a bunch of checks around. If you really think the economy needs a jump-start, let’s try suspending the Americans with Disabilities Act for a year.

As always, some people are experiencing hardship. As always, we can sympathize without rushing in to do more harm than good. In some ways, times are a little worse than they’ve been recently; in other ways, they’re better (personal income, for example, is at an all-time high).

The sub-prime crisis has led to a lot of home foreclosures and a lot of unhappy former homeowners. But it was sub-prime lending that allowed many of those people to be homeowners in the first place. The fact that you got to live beyond your means for a few years should not create a presumption that you’ll get to live beyond your means forever.

There’s also somewhat more unemployment than there was a couple of months ago thanks to slumps in housing and other industries. It’s hard to be unemployed, but there’s no way around the fact that people are going to have to find new ways to be useful. For example, we built too many houses during the sub-prime boom, so we need fewer builders now. Some builders will be unemployed while they figure out what to do next. It’s tough, but it happens all the time.

There’s a lot we can do to make our economy more productive and our children more prosperous — I’d start with an overhaul of the tax system — but none of it involves trying (almost certainly without success) to slow down the adjustment processes that are needed to keep this economy (or any economy) functional.

Steven E. Landsburg is a professor of economics at the University of Rochester and the author, most recently, of “More Sex is Safer Sex: The Unconventional Wisdom of Economics.”

Stimulus doesn’t stop adjustment
By Jason Furman

Steve,

You remind me a bit of the person who has only a hammer and for whom everything looks like a nail. You blame bloated government, badly designed taxes and an excess of regulation. I am a big fan of universal health insurance, Social Security reform, market-based solutions to global climate change, a two-state solution to the Israeli-Palestinian conflict and more funding for particle physics. But I am not suffering from the delusion that any of these are causing rising unemployment or that achieving any of my cherished goals would make a meaningful dent in the economy in 2008.

There is a simple reason why your diagnosis, and thus the remedy you prescribe, is implausible. All of the factors you cite have been relatively constant. They, together with many of the items on my wish list, are very important for long-run growth, overall efficiency and the prosperity and living conditions of our children. They are all big, complicated and controversial topics. But none of them has very much to do with the business cycle.

In the early 1980s the unemployment rate rose to almost 11%. In the early 1990s it rose to nearly 8%. It has increased 0.6% in the last nine months. None of these episodes can be explained by fluctuations in the design of the tax system or regulation. And even if we had the perfect tax, regulatory or health systems, we would still have business cycles if for no other reason than the “animal spirits” cited by John Maynard Keynes, which can lead to bouts of optimism and pessimism, driving consumer spending and investment up and down in ways that get propagated into business cycles.

Housing certainly is the primary culprit, but problems have spread well beyond that market. The associated problems have led to declining consumption and a credit crunch that threatens to reduce lending for a variety of productive activities. Employment in jobs related to residential real estate, including construction, has fallen by 264,000 in the last year — at the same time total unemployment has risen by 895,000. That is why the Federal Reserve, which traditionally avoids trying to target policies at individual sectors of the economy, is so involved. And it is why the odds of a recession, defined as “decline in economic activity spread across the economy” (emphasis added) have risen.

Economists are very much divided on the question of how to increase the economy’s productive capacity over the long run. But there is near universal agreement (and if it were not for you I probably would not have needed the word “near”) that when the economy is operating below its productive capacity the problem is insufficient aggregate demand, and the solution is to temporarily boost spending or investment through monetary or fiscal policy.

Such a solution prevents needless suffering but does not impede the adjustment you rightly note is needed. As I pointed out Wednesday, during the roaring 1990s the economy lost 252 million private sector jobs as a result of closing establishments or downsizing. But the economy was successful because it created 274 million new jobs — meaning that a low unemployment rate coincided with a dramatic shift in the makeup of U.S. jobs.

We can debate whether the economy is slipping into recession or about to rebound. We can debate whether the best tools are for the Federal Reserve to cut interest rates or Congress and the president to apply fiscal stimulus. And we can debate the most effective forms of fiscal stimulus. But to argue that the downturn could be solved by temporarily permitting discrimination against people with disabilities is just daft.

Jason

Jason Furman is a senior fellow and director of the Hamilton Project at the Brookings Institution. He served as a special assistant to the president for economic policy from 1999 to 2000.