Ben Stein and Paul Krugman, among others, feel that the US economy may be slipping into a Great Depression type high unemployment, long term Keynesian equilibrium. They feel that the tsunami of fear that first enveloped the financial markets, now threatens the economy. The result is that consumers and companies have cut back on spending, credit taps have gone dry and lending has come to a standstill, all of which raises the real possibility that economic activity will continue indefinitely at a level consistent with serious recession or even depression.
This fear psychosis and the possibility of getting trapped in its vortex, is being cited as a compelling enough reason for aggressive government intervention, both through large enough fiscal stimulus and bailouts of major firms and sectors. (Monetary policy has been driven to irrelevance as a stagflation beckons) Ben Stein writes that the costs of getting out of this turmoil are going to be high, "We cannot nickel-and-dime our way out of this".
How do we know we have reached the "Depression eve"? What are the ideal fiscal stimulus measures for the time and how large should they be? How should the fiscal measures be structured and scheduled? How do we select the firms and sectors to be bailed out? What should be the bailout help and how should it be structured? What should be the eligibility for bailout assistance?
These and other questions are going to be at the forefront of economic policy debates in the days and weeks ahead. None of these have clear answers, and decisions will be taken based on the individual and collective perceptions and judgements of the decision makers. One can only hope that decisions are taken as informed choices, untainted by ideological predilections and vested interests, perceptions of all stakeholders get appropriately aligned, and tons of luck follows.
Only time will tell whether these policies were good or bad. Such situations highlight the difficulty of economic policy making. There are no policy certainties in managing an economic situation.
Greg Mankiw, of all economists, now sets the Keynesian context, which leaves only the Government with the leverage to boost aggregate demand, though he still finds greater role for the monetary policy. But as Paul Krugman points out, the Keynesian stimulus and the war spending laid the foundations for robust post-war economic growth, which combined with inflation, created an environment in which interest rates were high enough in the subsequent normal times that monetary policy was effective at fighting slumps. In other words, the post-war effectiveness of Monetarism was largely dependent on the success of Keynesian demand management policies earlier.
Brad De Long finds virtue in old-fashioned Keynesianism, "the government must take a direct hand in boosting spending and deciding what goods and services will be in demand". He finds fault with the obsession of policy makers to prevent the princes of Wall Street from profiting from the crisis, which was reflected in the Fed-Treasury decision to let Lehman Brothers collapse in an uncontrolled bankruptcy without oversight, supervision, or guarantees. The Lehman Brothers bankruptcy created an extraordinary and immediate demand for additional bank capital, which the private sector could not supply.
The second lapse was the obsession with keeping private sector private, which meant a reluctance to avoid partial or full nationalization of the components of the banking system deemed too big to fail.