The Beatings Will Continue*

Who'll Stop the Pain? by Krugman (February 19, 2009)

So will our slump go on forever? No. In fact, the seeds of eventual recovery are already being planted.

Consider housing starts, which have fallen to their lowest level in 50 years. That’s bad news for the near term. It means that spending on construction will fall even more. But it also means that the supply of houses is lagging behind population growth, which will eventually prompt a housing revival.

Or consider the plunge in auto sales. Again, that’s bad news for the near term. But at current sales rates, as the finance blog Calculated Risk points out, it would take about 27 years to replace the existing stock of vehicles. Most cars will be junked long before that, either because they’ve worn out or because they’ve become obsolete, so we’re building up a pent-up demand for cars.

The same story can be told for durable goods and assets throughout the economy: given time, the current slump will end itself, the way slumps did in the 19th century. As I said, this may be your great-great-grandfather’s recession. But recovery may be a long time coming.

The closest 19th-century parallel I can find to the current slump is the recession that followed the Panic of 1873.** That recession did eventually end without any government intervention, but it lasted more than five years, and another prolonged recession followed just three years later.

You can see, then, why some Fed officials are so pessimistic.

Let’s be clear: the Obama administration’s policy initiatives will help in this difficult period — especially if the administration bites the bullet and takes over weak banks. But still I wonder: Who’ll stop the pain?

Krugman is prescient again as usual.

I've been rereading William Greider's Secrets of the Temple: How the Federal Reserve Runs the Country. He argues that Arthur Burns - Fed Chairman from 1970-78 - is the original History's Greatest Monster. An economics professor at Columbia, Burns was appointed by Nixon (thanks tricky Dick!) and had a reputation as a real hardass inflation hawk. However he was accused of priming the pump to help Nixon win the 1972 election. Nixon's Federal budget was already highly stimulative and the Fed added rapid money growth which approached 11 percent three months before the election. The following year had runaway inflation followed by the Fed tightening and a painful recession. Greider reports that some governors said Burns and the Fed had made an "honest mistake" and there was no conscious political manipulation of the economy. Later the Bush clan would blame Greenspan for causing Poppy to lose his re-election campaign to Clinton.***

Carter replaced Burns with G. William Miller and as Greider writes:

In Wall Street circles Miller was blamed for the surging inflation of 1978 and 1979, but Fed insiders understood that Miller had inherited errors made earlier by Burns - excessive monetary growth in late 1976 and 1977. One Fed official who worked closely with Burns attributed the mistakes to Burns's deep desire to win appointment to another term as chairman from the new Democratic administration elected in 1976. Money growth accelerated in the months right after Carters election - and Burns began a private campaign to ingratiate himself with the Carter White House. His campaign for reappointment ultimately failed, but monetary economists attributed the subsequent surge in inflation to Burns's overly generous money policy in the opening months of the Carter Adminstration.

There was also the oil shocks of the 1970s and unions could negotiate price hikes into contracts.
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* Until Morale Improves ... or Not.

** Wikipedia entry on the "Long Depression."

Monetary responses

In 1874, a year after the 1873 crash, the United States Congress passed legislation called the Inflation Bill of 1874 designed to confront the issue of falling prices by injecting fresh greenbacks into the money supply.[34] Under pressure from business interests, President Grant vetoed the measure.[34] In 1878, Congress overrode President Hayes's veto to pass the Silver Purchase Act, in a similar but more successful attempt to promote "easy money."[21]

Labor unrest
The United States endured its first nationwide strike in 1877, the Great Railroad Strike of 1877.

*** According to the Wikipedia entry on Burns:

When Vice President Richard M. Nixon was running for President in 1959–1960, the Fed, under the Truman-appointed William McChesney Martin, Jr., was undertaking a monetary tightening policy that resulted in a recession in April 1960. ^{[further explanation needed]} In his book Six Crises, Nixon later blamed his defeat in 1960 in part on Fed policy and the resulting tight credit conditions and slow growth. After finally winning the presidential election of 1968, Nixon named Burns to the Fed Chairmanship in 1970 with instructions to ensure easy access to credit when Nixon was running for reelection in 1972.