The First Time as Crisis, the Second as Memory

by Will on November 10, 2010

Every economic calamity strikes not once, but twice. First, when it strikes. Second, when the memory of it causes its survivors to err and invite a wholly different crisis. My thanks to Brad DeLong for making me realize this, via his paper on the 70s (linked below).

The Great Depression put many people out of work for years, and saw others working at a lower wage than they had previously known. It deeply affected those who went through it and saw the idle unemployed, and saw the foreclosures, and saw the hungry veterans marching. The memory remained vivid with them. And so in the 1970s, when policy-makers faced the deeply abnormal problem of simultaneous rising prices and rising unemployment, they chose at every turn to fight unemployment and risk further inflation. And so there was high inflation through the 70s, that, in combination with ill-conceived price controls, created Soviet-style shortages and lines. The Great Depression — alive only as a memory of something to be feared and avoided — had once again created untold havoc.

And this bout of inflation, which ended when the Federal Reserve raised interest rates in the early eighties, deeply affected people just as the Depression had one generation earlier. Its phantom sits with us still. And so, in a crisis that is much more typical and easy to diagnose, people are objecting to all possible remedies that could lower unemployment — on the grounds that these measures might cause inflation. This despite the fact that inflation has not been lower at any time in recent history. It shows no signs of budging. And moreover, a little more inflation would be a good thing! Before the 90s, inflation rates were typically 4 or 5 percent annually, much higher than the present zero-and-change rate of inflation. And moreover, should policy moves create inflation of more than that level– which would indicate a really robust recovery — the Federal Reserve has ample tools to get it back down! The interest rate is at zero percent! It can go nowhere but up! The experience of Paul Volcker in the 1980s shows that an interest rate of 10 percent or so is quite sufficient to quickly whip an excessive inflation. So these hysterical warnings that we’re entering a period of Weimar-like price increases are just crazy.

And yet they succeed in muzzling and prostrating the powerful, who choose inaction and timidity rather than just ignoring the claims of this mad inflation-phobia.

And so, inexorably, the memory of this cataclysm will remain still with us in the happy days after the present woes have ended. And it is a sure proposition that the next huge crisis will result precisely from the strength of these memories, and the force of our determination to avoid the next Panic of ’08.

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