What about the real economy?

I sort of follow a bunch of economics blogs. Naturally they’re all very much preoccupied with the financial crisis. There’s a lot of debate about Keynesian multipliers, whether the stimulus will work, liquidity traps, bursting bubbles, and the like. If you step back, it appears to be a conversation about how to use fiscal and monetary policy to halt a vicious cycle of declining expectations fueled by financial instruments no one really understands – essentially an attempt to keep the perceived economy from dragging down the real economy (as it is clearly now doing). The implicit assumption often seems to be that, if we could only untangle the current mess, the economy would return to its steady state growth path.

What I find interesting is that there’s little mention of what might have been wrong in the real economy to begin with, and its role in the current crisis. Clearly the last decade was a time of disequilibrium, not just in the price of risk, but in the real capital investments and consumption patterns that flowed from it. My working hypothesis is that we were living in a lala land of overconsumption, funded by deficits, sovereign wealth funds, resource drawdown, and failure to invest in our own future. In that case, the question for the real economy is, how much does consumption have to fall to bring things back into balance? My WAG is 15% – which implies a heck of a lot of reallocation of activity in the real economy. What does that look like? Could we see it through the fog of knock-on effects that we’re now experiencing? Is there something we could be doing, on top of fiscal and monetary policy, to ease the transition?

Bailout MetaRoundup & Alternatives


Several of the economics blogs I read have had useful roundups of bailout commentary. A few I find found useful:

Do we need to act now? on Economist’s View

9/26 Links on Economist’s View

NYT Economix’ analyst roundup

Greg Mankiw’s roundup of commentary

Update 9/29:

Real Time Economics’ Secondary Sources

Update 10/1: 

Greg Mankiw with more commentary

Alternative Plans:

Economists Against the Paulson Plan

Brad de Long on Krugman on the Dodd plan

WSJ Real Time Economics’ Text of Lawmakers’ Agreement on Principles

Thomas Palley on Saving the Financial System

Marginal Revolution on the Republican plan to rescue mortgages instead of buying mortgage assets

Marginal Revolution with a Modest Proposal (finding and isolating toxic assets)

Update 9/27:

Marginal Revolution with substitute bridges

Greg Mankiw with a letter from Robert Shimer with a nice analysis, including problems with Paulson, the lemons problem, and the Diamond, Kaplan, Kashyap, Rajan & Thaler fix

Update 9/28:

Real Time Economics on securitization

Brad deLong on nationalization (the Swedish model)

Update 9/29:

The Big Picture with Stop Targeting Asset Prices

Marginal Revolution asks, is the Sweden plan better?