The best I can say, and this is better than it sounds, is that recovery has a way of taking us economists by surprise. The 1991 and 2001 recessions look short and shallow in hindsight, but they seemed pretty bleak at the time, like classic “liquidity traps” where monetary policy was powerless to prime the pump. And the economy in 1980-82 seemed to be in absolute shambles. Most of the business cycle literature I’ve read deals with the causes of recessions and depressions, but I’m told there’s a substantial literature on the forces of recovery. I plan to acquaint myself with it this year, and to blog a fair bit about where recovery — especially a genuine, non-bubble-driven recovery — might come from.

The bad: Nearly half of Americans (48%) are either poor or near-poor, according to new Census data. That includes 49 million who are classified as living in poverty, plus 97 million who are classified as “near poor,” defined as having an income between 100 and 200 percent of the poverty line. Once upon a time many people would dismiss Census poverty data by noting that they failed to include government welfare spending and other anti-poverty tax and transfer policies, and also failed to adjust for the huge variation in the cost of living in different regions of the nation. But the new figures reflect the recently revised Census methodology, which answers those objections. One might also object that the low-income threshold is actually quite high — $45,000 for a family of four — but I would guess that the objectors have not tried to support a family of four on that amount lately. The AP article quotes Robert Rector* of the Heritage Foundation with the old conservative argument that many of these people have TV’s, cars, and houses, ergo they’re not really materially deprived, but I think he’s missing a couple things:

• Poverty is a relative measure as well as an absolute measure. Yes, $45,000 would have been opulence for, say, a family in colonial America (which apparently had the highest standard of living in the world at the time). But colonial families grew their own food, spun their own cloth, and were otherwise generally self-sufficient. Also, yesterday’s luxuries often become today’s necessities. For example, two decades ago I spent about $25 a month to stay connected, in the form of basic landline service. Today, staying connected costs me about $350 a month, for cable TV and Internet, cellphone, etc. You can live without all those things, but when everyone around you has them, you will know deprivation. Just because it’s a social construct doesn’t mean it’s bogus.
• The burden of consumer debt: Entering the recession, consumer debt was at an all-time high relative to income. Household debt service payments averaged 14% of income and about 28% for renters. Since the recession began, many households are obviously much poorer and finding it much harder to make those payments. Many have, of course, not merely fallen behind but lost their houses and other collateral. The overall debt-service-to-income statistics show that households are successfully deleveraging,with the number down to 11%, but the average surely hides a lot of variation. I expect debt is weighing very, very heavily on most near-poor households — those that still have their houses, that is.

When members of a household are unemployed or underemployed, they are probably just barely keeping up with the living standards of the community or even their own living standards of a couple months or years ago. It’s gotta be painful. Pundits and politicians ignore that reality at their own peril.

(*Also the same person from whom I first heard the suggestion that government policy on poverty should be based on the words of the apostle Paul in 2 Thessalonians 3:10: “That if any would not work, neither should he eat.” I last heard it from Michele Bachmann.)

Fiscal conservatism hasn’t fared well since recession began in late 2007. Even without the countercyclical tax cuts and spending increases that many governments enacted, falling GDP has caused most countries’ debt/GDP ratios to skyrocket. Even Germany’s is now over 80%. (And contrary to conventional wisdom, it’s just not true that the European economies now facing debt crises, with the exception of Greece, were running up huge deficits and debt prior to the recession; c.f. Krugman and Dean Baker.)

The news for much of this year has been of sovereign debt crises in Greece and the other “PIIGS” countries (from the “BAFFLING PIGS” mnemonic for the first 12 euro members), Portugal, Ireland, Italy, and Spain. But the most shocking economic news for me this year was the recent report that they held a German bond auction and “nobody” came. Not really nobody, but the German government was only able sell three-fifths of the “bunds” they intended to sell. To be sure, they’d have sold more if they’d been willing to accept lower bids; these bonds were supposed to pay just 2% interest, and that’s about where the yields ended up. The linked article quotes some observers who say the weak auction was due to investor concerns that Germany might be left holding the bag for PIIGS and other euro countries that can’t pay their debts. Others have said it was mostly about currency risk, i.e., the risk that the euro might massively depreciate or even crack up over the 1o-year lifetime of the bonds.

Could a euro crack-up happen? Some experts think it actually will happen, perhaps soon. Peter Boone & Simon Johnson:

‘The path of the euro zone is becoming clear. As conditions in Europe worsen, there will be fewer euro-denominated assets that investors can safely buy. Bank runs and large-scale capital flight out of Europe are likely.

‘Devaluation can help growth but the associated inflation hurts many people and the debt restructurings, if not handled properly, could be immensely disruptive. Some nations will need to leave the euro zone. There is no painless solution.

‘Ultimately, an integrated currency area may remain in Europe, albeit with fewer countries and more fiscal centralization. The Germans will force the weaker countries out of the euro area or, more likely, Germany and some others will leave the euro to form their own currency. The euro zone could be expanded again later, but only after much deeper political, economic and fiscal integration.’

At least the run on the euro is off to a slow start. The euro has had a rough November, but its decline against the dollar was only four and a half cents, or about a penny per week. The euro’s price against the dollar is still higher now than it was in most of 2005-2006.

As has been noted, euro membership has arguably gone from a privilege to a bane for these weaker countries, and possibly for all of them. Before the recession, their governments and firms could borrow cheaply on the international market, as the relatively stable euro provided insurance for the lenders, against getting repaid in devalued currency. But now euro membership takes away two key stabilization tools for them: monetary stimulus from their own central bank, and currency adjustment (a devaluation could help GDP through increased net exports).

The messy euro situation looks like the big wild card for the U.S. economy. (Here the conventional wisdom is actually correct, in my view.) Although the blow to U.S. exports from a double-dip European recession could theoretically be offset by more expansionary fiscal policy, the political prospects for additional stimulus have been dim for a long time. Things would have to get a whole lot worse here before any new stimulus could get past the Republicans in Congress, and maybe not even then.

Technically, the precise reason is that the low number of jobs added, 120,000 (which is well under the 210,000 needed to restore 5% unemployment in eight years) comes from the BLS’s survey of companies (the “establishment survey”), whereas the 8.6% number comes from its separate survey of households. But even in the household survey, the basic story is the same. The longstanding economic definition of unemployed is not merely “not employed” but “not employed yet actively looking for work.” And it looks like the bulk of the reduction in unemployment was from people who stopped looking.

In the household sample, total unemployment fell by 594,000, which looks great, except that employment grew by less than half that (278,000). “Not in the labor force” (i.e., not working and not looking) grew by much more (487,000). The labor force itself (employed plus unemployed) shrank by 315,000. It’s hard to blame people for giving up looking for work when there are currently 4.2 times as many unemployed as there are job vacancies. (The number was 1.8 when the recession began three years ago.)

Rather than focus on the official unemployment rate or broader measures like the U-6 unemployment rate (now 15.6%; includes discouraged job-seekers and involuntary part-timers), I prefer to focus on the employment-to-population ratio, which is a simpler measure that avoids messy distinctions (e.g., actively vs. passively looking for work vs. not looking at all but might take a job if offered). The employment-to-population ratio has hardly changed at all since September 2009, fluctuating narrowly around its current value of 58.5%. (By comparison, it was 62.0% at the worst of the 2001 recession hangover.)

One could wax metaphysical about work as a bourgeois construct and argue that people are finding spiritually rewarding alternatives to work, but that doesn’t seem to be the case for all that many people here. The BLS report shows that 6,595,000 adult Americans are currently not working and not looking but want to work now. That number (seasonally adjusted) has never been larger — not even at the trough of the recession in mid-2009 and not even when the unemployment rate was over 10%.

If the labor force keeps on shrinking, the official unemployment rate could fall fast, but that’s probably not how we want to get there.

UPDATE 3 DEC. 2011: Brad DeLong does the number crunching I was too lazy to do and produces a specific breakdown of how much of the unemployment rate decline came from labor force shrinkage (25 basis points, or 0.25 percentage points) and how much came from employment growth (15 basis points). So if nobody had left the labor force, the unemployment rate would have fallen to 8.85%.

The story is not from a conspiracy peddler or a grandstanding politician, but from Bloomberg News, and actually involved investigative reporting. The $13 billion figure is the profit the banks earned from subsidized low-interest loans, etc. The Fed’s total commitment, including loan rollovers, guarantees, and lending limits, was an eye-popping $7.7 trillion. Now, when I first heard a similar figure presented by Congressman Bernie Sanders a few months ago, it looked like a distortion, because it included rollover loans (if I loan you $100 and you pay me back a month later and get a new loan and so on for 12 months, have I loaned you $100 or $1200?) and the total assets on the Fed’s balance sheet have never been much larger than $2 – 2.5 trillion, with a maximum of $1.5 trillion that could be loans to banks. But the non-rollover figures are still staggering. The banks “required a combined $1.2 trillion on Dec. 5, 2008, their single neediest day.”

Other areas for concern (or outrage, take your pick):

• These loans covered a much longer period that one might think. They were greatest at the height of the fall 2008 crisis, but they began in August 2007 and lasted until April 2010. Was such a massive amount of subsidized lending justified this whole time?
• The identities of the banks were kept secret, until Bloomberg obtained them via a Freedom of Information Act request. Now, the Fed’s usual lender-of-last-resort apparatus, the discount window, is supposed to keep borrowers’ identities secret, but traditionally there was at least supposed to be some stigma attached to discount loans, so that banks didn’t take advantage of the Fed’s low interest rates by borrowing too much. The Fed wouldn’t out them, but it might audit them. While there is a rationale for keeping the borrowers’ names secret — you don’t want to spark a panic by signaling that these banks are in trouble — surely this secretiveness should have some limits? Last year’s Dodd-Frank financial reform bill requires disclosure of discount loans after a two-year lag. This seems modest to me, but tellingly, Fed officials are wringing their hands and saying this will destroy discount lending.
• What kind of lender of last resort charges the lowest interest rate in town? The interest rates on these loans got as low as 0.01%. This is a huge subsidy to banks that supposedly can’t get loans anyplace else. A few years ago the Fed reset its discount rate (the rate it charges its borrowers) a notch above the federal funds rate (the rate banks charge each other), presumably so that banks wouldn’t take advantage of the Fed’s low rate. Yet the big banks got to borrow at interest rates below that, and below what anyone else was offering.
• The loans appear to have been completely unconditional. This could maybe be justified at the peak of the 2008 crisis, when it seemed like fast action was needed, but before and after too? The Federal government’s TARP loans to banks (which, at $700 billion, now appear puny by comparison) were basically unconditional but at least attempted to impose some restrictions on banker bonuses. With the benefit of hindsight and time, more meaningful restrictions, like radically changing the pay structure so as to discourage taking wild risks with other people’s and taxpayers’ money, and limits on leverage, could be devised, and the Fed wouldn’t have worry about getting them through Congress.

I still favor an independent central bank, with minimal political meddling. But these loans don’t look like the work of an independent entity at all. They scream “regulatory capture” by big banks. Gigantic, secret, and unconditional subsidies like these are a recipe for moral hazard that could make the next financial crisis one of those sequels that’s bigger, costlier, and suckier than the original.

Audit the Fed? Yeah, why not.

UPDATE, 2 DEC. 2011: Felix Salmon and Brad DeLong teach me that my point that the lender of last resort should not have the lowest rates in town was made a long, long time ago, by Walter Bagehot: “Lend freely, but at a penalty rate.” DeLong writes:

“Without the Fed and the Treasury, the shareholders of every single money-center bank and shadow bank in the United States would have gone bust.”

‘A 1985 interview with von Hayek in the March 25, 1985 issue of Profil 13, the Austrian journal, was just as revealing. Von Hayek sat for the interview while wearing a set of cuff links Reagan had presented him as a gift. “I really believe Reagan is fundamentally a decent and honest man,” von Hayek told his interviewer. “His politics? When the government of the United States borrows a large part of the savings of the world, the consequence is that capital must become scarce and expensive in the whole world. That’s a problem.” And in reference to [David] Stockman, von Hayek said: “You see, one of Reagan’s advisers told me why the president has permitted that to happen, which makes the matter partly excusable: Reagan thinks it is impossible to persuade Congress that expenditures must be reduced unless one creates deficits so large that absolutely everyone becomes convinced that no more money can be spent.” Thus, he went on, it was up to Reagan to “persuade Congress of the necessity of spending reductions by means of an immense deficit. Unfortunately, he has not succeeded!!!”’

The snippet comes from this article about David Stockman, former Republican Congressman and Reagan Office of Management and Budget Director. Another keeper:

‘The deficits were intentional all along. They were designed to “starve the beast,” meaning intentionally cut revenue as a way of pressuring Congress to cut the New Deal programs Reagan wanted to demolish. “The plan,” Stockman told Sen. Daniel Patrick Moynihan at the time, ” was to have a strategic deficit that would give you an argument for cutting back the programs that weren’t desired. It got out of hand.”’

All of which is worth remembering the next time you’re subjected to the hand-wringing of yet another media or political figure who says the deficit is our biggest problem. (Usually these people don’t bother to mention the 25 million unemployed and underemployed, or the $1 trillion output gap.) Yes, the deficit is a problem, but don’t forget where it came from, and especially don’t trust anyone who says reversing the 2001 tax cuts or cutting military spending can’t be part of the solution.

Good, says Paul Krugman. To be precise, he said that last week. His reasoning was that cutting spending is counterproductive in a time of economic depression, as it will just exacerbate the depression, so it’s best that they didn’t make a deal to cut spending. Today, he’s a bit more nuanced, noting a Bloomberg.com story about how the supercommittee’s failure is rattling markets but highlighting this aspect of the story (Krugman’s words):

‘. . . what it actually says is that market players fear that the absence of a debt deal means no stimulus. So the actual fear is not that spending won’t be cut enough, it is that it will be cut too much — which actually makes sense, and is consistent with the action in stock and bond markets.

‘But how many readers will get that? The way it’s presented reinforces the false notion that the deficit is the problem.’

Bad, says Kevin Drum. At least if you’re someone like Kevin Drum, Paul Krugman, or me, who thinks it’s foolish to cut social spending in a depression and really isn’t all that keen on slashing the social safety net in general. Unlike Krugman, Drum thinks many if not most of the automatic spending cuts will go into effect. The deal is only good if you’re a Republican who lives to cut social programs. In other words, the Democrats got rolled again, just as in the bogus “debt ceiling authorization” debate. Drum:

‘In any case, this should basically be viewed as a total victory for Republicans. Any alternative plan would have included some tax increases, so failure to come up with an alternative means that we get a big deficit reduction that’s 100% spending cuts, just like they wanted. And the 50-50 split between domestic and defense cuts was always sort of a joke. Republicans never had any intention of allowing the Pentagon’s half of the cuts to materialize, and the domestic spending half of the cuts was about as big as they wanted them to be. Big talk aside, they know bigger cuts would run the risk of seriously pissing off voters.

‘So Republicans got domestic spending cuts that were about as big as they really wanted. They know they’ll never have to implement most of the defense cuts. And there are no tax increases.’

Irrelevant, say the bond markets. The demand for ten-year U.S. Treasury bonds was actually up slightly today, whereas really bad news about the long-term U.S. fiscal position should send demand down and interest rates up. Either the market regards $1.2 trillion over 10 years as no big deal (and it is rather small compared with a national debt of $14 trillion), or they were expecting the supercommittee to fail all along. Or both.

OWS may pale in comparison to these country examples. Yet it would be both foolish and arrogant to dismiss three important similarities:

First, the desire for greater social justice is a natural consequence of a system shown to be blatantly unfair in its operation and, to make things worse, incapable of subsequently holding accountable people and institutions.

In the US, it is about a system that privatized massive gains and then socialized huge losses; allowed bailed-out banks to resume past behavior with seemingly little regulatory and legal consequences; and is paralyzed when it comes to alleviating the suffering of victims, including millions of unemployed (too many of whom are becoming long-term unemployed, slipping into poverty, and losing access to safety nets). The result is a visible and growing gap between the haves and the have-nots in today’s America.

Second, OWS’s followers will grow as our economy continues to experience sluggish growth, persistently high joblessness, and budgetary pressures that curtail spending on basic social services (such as education and health). Other internal and external realities will also play a role.

At home, our elected representatives seem incapable as a group to respond properly to severe economic and social challenges. Continuous (and increasingly nasty) political bickering undermines the required trio of common purpose, joint vision, and acceptance of shared short-term sacrifices for generalized long-term benefits.

Internationally, Europe’s deepening debt crisis amplifies headwinds undermining an already sluggish American economy that, in the absence of better policy responses, is on the brink of another recession, Should the economy slip from treading to taking on water, the social implications would be profound given that we already have high unemployment, a large fiscal deficit and, with policy interest rates already floored at zero, little policy flexibility.

Third, advances in social media help overcome communication and coordination problems that quickly derailed similar protests in the more distant past.

I couldn’t have said it better myself. I can only hope that el-Erian will speak out forcefully for better government policies, namely the type of wholesale changes that we need to tackle these huge problems that he identifies.

The tonic du jour is nominal GDP targeting, by which the Fed would try to reach a certain level of nominal GDP — say, $16. 3 trillion (the current level of potential GDP assuming that, as I’ve read, current GDP is 7% below its potential. Do the math and that’s a $1.1 trillion gap between current and potential GDP). Christina Romer, Obama’s first head of the Council of Economic Advisors, recently backed this approach in a New York Times op-ed. Scott Sumner has been pushing it all along, and there’s now a whole new school of macroeconomics, “market monetarism,” which revolves around nominal GDP targeting. (Economists: see here for Ed Dolan’s helpful explanation of how nominal GDP targeting is a form of Milton Friedman-style monetarism.)

Now, once the Fed announces this new target, how does it actually get there? Romer provides the clearest answer I’ve seen yet:

‘Though announcing the new framework would help, it probably wouldn’t be enough to close the nominal G.D.P. gap anytime soon. The Fed would need to take additional steps. These might include further quantitative easing, more forceful promises about short-term interest rates, and perhaps moves to lower the exchange rate. . . .’

‘Nominal G.D.P. targeting would make it more likely that the Fed would take these aggressive actions.’

That’s clear, but so is weak tea. None of these actions sound all that different from what the Fed is already doing. Proponents of nominal GDP targeting seem to be counting on a huge “announcement effect,” i.e., that people will hear about the Fed’s commitment to raising GDP and will assume that Fed will make it happen. Yet the Fed’s goals already include maximum sustainable employment, which is the employment rate you’d have at potential GDP, so why should this change the public’s behavior? (Although there is a difference between monetary policy goals, like low unemployment, and targets, which now include interest rates, it’s a rather subtle one. I don’t see why it would move markets.)

Another popular tonic is a higher inflation target. Right now the Fed’s unofficial but almost universally acknowledged inflation target is 2%, and for the past few years the core inflation rate has been below or near 2%. When inflation is very low, real interest rates (nominal interest rates minus inflation) can still be high even when nominal rates are also low. In the U.S. in the early 1930s, for example, nominal rates plunged toward 0%, but deflation was raging, so real interest rates were actually quite high. Economic historian Nick Crafts, in a Financial Times op-ed, says that Britain’s recovery from the Great Depression was greatly aided by a combination of low nominal interest rates and rising inflation rates — i.e., negative real interest rates — which promoted homebuilding. Crafts says targeting a higher inflation rate — say, 4% — could do the trick today.

Again, I just don’t see how you get there. Would I like to see lower real interest rates? Sure. But for 4% inflation to happen, a lot of other things have to happen first. Banks need to loan out their excess reserves, people and businesses need to buy stuff with those loans, the money needs to be redeposited in banks,  more loans need to be made, etc. That’s how monetary policy works — when it works. Right now, the banks have over a trillion dollars in excess reserves that they’re just sitting on. Banks are not eager to lend, and businesses and households are not eager to borrow. Classic liquidity trap.

Nominal GDP targeting and higher inflation targets sound radical, but are they? Chicago Fed President Charles Evans said in a speech this week that he viewed the 2% inflation target as a medium-run target, not a short-run target, saying that as long as inflation averaged out to 2% over a multi-year period, higher inflation rates would be acceptable in the short term. That statement is consistent with either a nominal GDP target (shoot for low inflation when real GDP is high, tolerate higher inflation when real GDP is low) or an inflation target (let inflation rise when unemployment is high), which suggests that neither of those policies is all that new. Both seem to promise much more than they could ever deliver.

Stated differently: The economy is in a liquidity trap (macroeconomists). Or, monetary policy has shot its wad (Pres. Obama to economic adviser Christina Romer in their first meeting, according to Ron Suskind’s Confidence Men). Krugman has been saying this for three years now, and so have a lot of other economists. But until today, I had yet to hear it from a Fed official. Fed Chairman Ben Bernanke has called for Congress to pursue a more expansionary policy fiscal policy, thus implying but not explicitly saying that the Fed has done just about all it can. But in a speech today, Chicago Fed President and Federal Open Market Committee member Charles Evans had the guts to state the obvious:

“I largely agree with economists such as Paul Krugman, Mike Woodford and others who see the economy as being in a liquidity trap: Short-term nominal interest rates are stuck near zero, even while desired saving still exceeds desired investment. This situation is the natural result of the abundance of caution exercised by many households and businesses that still worry that they have inadequate buffers of assets to cushion against unexpected shocks. Such caution holds back spending below the levels of our productive capacity. For example, I regularly hear from business contacts that they do not want to risk hiring new workers until they actually see an uptick in demand for their products. Most businesses do not appear to be cutting back further at the moment, but they would rather sit on cash than take the risk of further expansion.”

Evans went on to suggest a number of measures the Fed should still take, like buying up more mortgage-backed securities to get the housing market going (I’m still on the fence on that one — yes, this is the economy’s weakest sector, but how do you do this without reinflating the housing bubble?), while keeping mum on the subject of whether this would do anything more than just nudge the economy forward, as opposed to bringing us anywhere near full employment. I suppose the question is moot, as long as nobody else is willing to act. Congress is not only unwilling to consider fiscal stimulus but seems to be on the verge of massive budget cuts, either by following the “super committee’s” blueprint or letting an autopilot crash the plane.

Hat tip to Judith Osofsky for today’s video: