The Great Deflation

I never liked the term "The Great Recession," because this is not an ordinary recession, not even a great one. It is a period of protracted deflation, where weak demand, declining incomes, and falling asset prices keep dragging the economy downward into a self-deepening sinkhole.

With the latest unemployment numbers, the evidence keeps accumulating that this will be a prolonged economic stagnation. The unemployment rate -- stuck around 9 percent -- is not as bad as that of the Great Depression, but in some respects the prognosis is equally grim.

We are already entering year four of the crisis, with a strong recovery nowhere in sight. Household income has declined by 10 percent since the recession began in 2007. GDP growth improved slightly, to 2.5 percent, in the third quarter, but only because households began borrowing more, and that can't continue for very long. Consumer income was actually down 1.7 percent.

If you compare our progress with the comparable period in the Great Depression, things actually looked more promising in the mid 1930s. By late 1933, on the fourth anniversary of the stock market crash, strong economic growth had resumed. The economy expanded by 11 percent in 1934, 9 percent in 1935, and 14 percent in 1936.

By contrast, optimists today hope the economy will somehow reach 3-percent growth. The Federal Reserve, once again, has just revised its growth forecasts downward to well under 3 percent, and expects unemployment still to be in excess of 8 percent in 2013.

By the end of year four of the Great Depression, the banking crisis was over. The 1933 Glass-Steagall Act, deposit insurance, and the Reconstruction Finance Corporation stabilized the financial system. Bank failures ceased -- while in the current crisis our banks are still a mess.

The Roosevelt administration dealt forthrightly with the housing crisis of that era, creating a Home Owners Loan Corporation that made direct loans to one homeowner in five, to keep people from losing their homes. In the current crisis, some 10 million homeowners are still on track to default, and the Obama administration keeps producing half-measures too feeble to solve the problem.

Four years into the Roosevelt administration, unemployment was still high, but Roosevelt was re-elected by a landslide in 1936 because things were improving and people felt he was on their side. It's anybody's guess who will win the White House in 2012.

A lot of pundits seem to think that the current crisis has no solution, and that we just have to get used to a prolonged period of slow growth, high unemployment, and general belt tightening. This is nonsense, but the remedies that might actually solve the crisis are mostly outside mainstream debate.

A real recovery program would be one part massive public investment -- partly financed by higher taxes on the wealthy, partly by deficits -- and one part a complete reconstruction of the financial system so that it returns to its role of servant of the real economy rather than master.

Neither party is proposing this, and proponents of a new political center are mainly promoting austerity.

The Republicans would drastically cut taxes, shrink public spending, and repeal regulations. All this, presumably, would liberate businesses to create more jobs.

However, taxes were cut several times under President Bush, but that didn't prevent the recession. Government revenues are already at their lowest share of the economy since the 1950s.

The financial collapse was caused mainly by the repeal of regulations that had contained the speculative tendencies of bankers. It's hard to see how more deregulation would promote entrepreneurship in an economy when consumers lack money to buy products.

Centrist groups like Third Way and No Labels decry the extreme partisanship and call for a new consensus to deal with the crisis. These and similar groups begin with a plea for budget discipline.

But austerity would not solve the economic crisis either. With unemployment high, consumer demand depressed, and businesses understandably hesitant to invest, more belt-tightening will only worsen conditions.

The Obama administration, for its part, has tried a blend of modest economic stimulus and a long-term path to budget balance. Obama's latest jobs program proposed a total of $447 billion over 10 years -- better than nothing but far from enough to produce a sustained recovery. Even if by some miracle Republicans were to relent, the stimulus is insufficient.

Obama's original Recovery Act, enacted back in February 2009 when the Democrats controlled both Houses of Congress, spent $775 billion over three years. But during the same three years, state and local governments cut about $460 billion. So the net government stimulus was barely $100 billion a year in a more than $14-trillion economy. Obama's own top advisers considered the sum inadequate.

In the Great Depression, it was the massive spending of World War II that finally cut unemployment to less than 2 percent and then powered the postwar recovery. The wartime deficits were astronomical -- nearly 30 percent of GDP in the last year of the war. But after the war, high growth paid down the debt, which was nearly twice the level of the current debt relative to GDP.

Nobody in mainstream American politics is proposing public outlays anywhere near this scale. So the likelihood is for continued economic deflation -- and deepening voter frustration.

Absent a more radical recovery program than anything on offer in mainstream politics, the chief executive elected in 2012, whether Obama or his Republican opponent, is likely to be the next Herbert Hoover, presiding over a prolonged economic slump with popularity to match.

Ours is a very resilient political system. But before America emerges from this combined economic and political crisis, it will take some new combination of mass reform movements at the grassroots and more effective leadership at the top than we've seen in a very long time.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is A Presidency in Peril.