That, according to a speech Larry Summers just gave to the Brookings Institution, is what the Obama administration thinks we're in. "One of the most important lessons in any introductory economics course," he said, "is that markets are self-stabilizing. When there is an excess supply of wheat, its price falls. Farmers grow less and others consume more. The market equilibrates. When the economy slows, interest rates fall. When interest rates fall, more people take advantage of credit, the economy speeds up, and the market equilibrates." That, at least, is how it should go. But at the moment, the normal market processes are broken. "It was a central insight of Keynes’ General Theory that two or three times each century, the self-equilibrating properties of markets break down as stabilizing mechanisms are overwhelmed by vicious cycles. And the right economic metaphor becomes an avalanche rather than a thermostat. That is what we are experiencing right now." Summers went on to tick off five of the mechanisms that seem to be feeding on themselves rather than being tamed by the market's Econ 101 tendency towards balance:* Declining asset prices lead to margin calls and de-leveraging, which leads to further declines in prices. * Lower asset prices means banks hold less capital. Less capital means less lending. Less lending means lower asset prices. * Falling home prices lead to foreclosures, which lead home prices to fall even further. * A weakened financial system leads to less borrowing and spending which leads to a weakened economy, which leads to a weakened financial system. * Lower incomes lead to less spending, which leads to less employment, which leads to lower incomes.
"This is the paradox at the heart of the financial crisis," he continued. "In the past few years, we’ve seen too much greed and too little fear; too much spending and not enough saving; too much borrowing and not enough worrying. Today, however, our problem is exactly the opposite. "In other words, we now need more greed, more spending, and more borrowing. Which seems sort of right. The rest of Summers' speech was an effort to talk up both the economy and the administration's economic plans. He tried to detail "the magnitude of the opportunity" before us by noting that the Dow Jones hit is 1966 level earlier this week. "That the market would be at essentially the same real level as it was in 1966 when there were no PCs, no internet, no flexible manufacturing, no software industry, and when our workforce was half and our net capital stock was a third of what it is today, may be regarded by some as the sale of the century," Summers said. I'm not sure that actually makes much sense -- the Dow Jones is not a measure of economic size -- but it's certainly a good soundbite if you're trying to get people to invest. Full speech after the fold. Here at the Prospect, we're committed to primary documents.
