If actions taken by the Administration, the Congress, and the Federal Reserve are successful in restoring some measure of financial stability – and only if that is the case, in my view – there is a reasonable prospect that the current recession will end in 2009 and that 2010 will be a year of recovery.
– Federal Reserve Chairman Ben Bernanke, Semiannual Monetary Policy Report to the Congress, February 24
We mustn’t assume that all problems are solvable in the short period. There are problems that we cannot solve or which trying to solve them quickly may do more harm than good.
– Friedrich von Hayek on “Meet The Press”, June 22, 1975
Bernanke gave a good speech this morning and I’d recommend it to people to read. In the first section, “Recent Economic and Financial Developments and the Policy Responses”, he gives a good overview of the current crisis and government’s policy response.
But it’s a paragraph in the last section that to me is the key. He begins: “This outlook for economic activity is subject to considerable uncertainty, and I believe that, overall, the downside risks probably outweigh those on the upside.” I agree. He then goes on to say that the key to economic recovery is the government’s success or failure in “restoring some measure of financial stability”.
I have the completely opposite view. I believe all these goverment policies are ultimately distortive. The market naturally restores equillibrium because individuals and businesses adapt themselves to the new reality. Businesses scale back their operations in response to decreased sales and profits. Unsustainable enterprise are liquidated and their labor and capital allocated to more efficient uses. Individuals cut back spending in response to decreased income and wealth (i.e. housing and stock market collapse). It is a process and it takes time – but it works. The real risk, in my opinion, is that government policies further de-stabilize the economy by impeding the market from making the necessary adjustments to the new economic reality.
Therefore, my conclusion is the exact inverse of Bernanke’s:
If the government stays out of the way to a great enough extent to allow the market to stabilize by its own natural tendencies – and only if that is the case, in my view – there is a reasonable prospect that the current recession will end in the next year or so and that 2010 will be a year of recovery.