I’ve spent much of the past year both on Kudlow & Co. and in columns arguing with Jared Bernstein, Robert Reich, Barry Ritholz, Jonathan Chait, and others about whether or not we’re in a recession. These folks (some of whome are members of the “Kudlow Caucus”) were certain we were, while I, along with Larry and other supply-siders, thought we were not. As of this week, and a revised GDP-growth number of 3.3 percent for the second quarter, we now know most authoritatively that the recessionistas were wrong.
Bernstein and Reich, in particular, were flatly wrong. They argued that tax cuts favoring the rich worsened income inequality; that this inequality, coupled with the excessive volatility of free-market capitalism, led to plunging home prices that not only made people feel poorer, but in a reverse “wealth effect” caused a plunge in consumer confidence; and that all this presaged a plunge in consumer spending, which ultimately drove the economy into recession.
The way out of this spiral, they said, can only be a combination of massive government spending and some form of consumer-rebate “stimulus package” to restore spending and, through spending, economic growth. This scenario was, and is, nonsense on stilts.
The housing crisis wasn’t created by free-market capitalism, but by government meddling. In particular, the crisis is rooted in a raft of government regulations that forced banks to ignore traditional lending standards — such as credit history, income, and neighborhood economic conditions — and instead embrace non-culturally “discriminatory” lending practices based on racial-identity politics. Once the banks were forced to make loans based on political, rather than financial, criteria, and once Fannie and Freddie were forced to buy these loans in the secondary mortgage market, collapse was inevitable.
In addition, there is no wealth effect from falling home prices. People generally don’t spend based on the value of their homes, partly because people almost never know the value of their homes. Furthermore, for every seller taking a bath during a down market there is a buyer getting the deal of a lifetime. Predictions about consumer attrition simply have not materialized because, as Milton Freedman taught us, spending patterns are based on long-term income expectations. For this and many other reasons the much-heralded consumer collapse has yet to appear.
Now let’s look at what did happen. The 2003 tax cuts increased wealth in every segment of the economy, sparking a multi-year boom. But these tax cuts were passed with expiration dates, and the first Bush-tax-cut expiration occurred at the end of last year when small businesses lost some of their ability to take a tax deduction on purchases of business equipment. As the chart shows, this event coincided with a trough in the economic cycle. This past winter, congressional Republicans successfully fought to add the small-business tax breaks to what otherwise was a useless stimulus package, and the market for business equipment recovered in the spring. Voilà — the economy snaps back to 3.3 percent GDP growth.
Will the New York Times and the rest of the media storm-crows who spent most of the spring and summer cackling the “recession” word admit their error and reverse course? I think you already know the answer to that question.
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