The Biggest Mistake of Our Generation

I haven't posted much on economics in the last year or so. The news is overwhelmingly depressing and I feel exasperated on the subject. The missteps of our politicians, most of which were entirely preventable, continue to cause enormous suffering on the parts of millions of people - especially young workers looking to start their careers. The cumulative effects of these errors will be felt for decades. People's lives are being destroyed and few seem to consider it a big deal.

The worst part of it all is that many people truly believe that there must be suffering for the situation to improve, but this is how people felt during the Great Depression too. "The weak must be culled!", but there's an aspect of moralization to that argument that I'm uncomfortable with. This is macroeconomics, not metaphysics. The Great Depression can largely be explained as a money supply problem (there wasn't enough money/liquidity in the economy much like the babysitter co-op problem); an answer which makes many uneasy as it's a somewhat simple technical fix. People believe that it must be more complex, but it simply isn't.

This morning the New York Times ran this piece: Defecit Reduction is Seen by Economists as Impeding Recovery. No shit? Every respectable economists knows that reducing government expenditures during an economic downturn is inadvisable and they've been saying so all along. The article goes on to rationalize what happened. This is what's been so frustrating over the last five years, giving credence to ideas that have been proven demonstrably wrong - repeatedly. Few people will step up and say "Yeah, I've focused on the national deficit and reduced government spending but it turns out I was wrong. Let's focus on unemployment." Not going to happen, so they obfuscate with rhetoric and the suffering continues.

In the meantime the American public thinks there's an actual debate going on. There isn't one. Textbook New-Keynesian economics has been validated. We've all been screwed and my generation is fucked. If anything this is an understatement.

The data that's been coming in over the last five years is in line with typical macroeconomics textbooks that any econ 101 student is exposed to. If the following were a test question to me in undergrad:

The current economic indicators are as follows (May 2013): 

• Unemployment: 7.6% 
• GDP Growth: 1.7% (2011) 
• Inflation: 1.5% 
• 10 Year Treasury Bill: 1.8% 
• 10 Year Treasury Bill Inflation Protected (TIPS): -0.5% 
• 30 Year Treasury Bill: 2.98% 
• 30 Year Treasury Bill Inflation Protected (TIPS): 0.62% 

Describe the most advantageous course of action which a central government could, through fiscal and monetary policy, increase GDP growth and lower unemployment in both the short and long run.

My answer would be something along the lines of:

Short answer - The government should borrow money and invest in itself because there are many idle workers, slow economic growth, and financing costs are zero or negative (!). Although politically it may be unpopular to borrow money to spend, no other entity is large enough to assume this role, so the federal government must.

Longer answer - Monetarily the Fed should reduce rates (done, it's at 0%) and increase the money supply (done) while the Federal government should increase its expenditures (it's done the opposite) and encourage state and local governments to do similarly (they've been the worst). Although it would be advantageous to spend on infrastructure, education, and other areas that produce long term benefits, where the money is spent is somewhat irrelevant (although politically unpopular, Keynes burying money in jars). This spending can be financed by the historically low interest rates (negative rates on a 10-year bond, who wouldn't want to get paid to borrow money?). Further, the federal government should reduce taxes on those who are most likely to spend additional income, the poor, as the multiplier effect is larger  (it's done the opposite). To add to the last point, social safety net programs should be expanded (they were for a while but they're being cut back now) as those with little money are most likely to spend any additional income which would create a larger multiplier effect.