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'Financial Shock: Global Panic and Government Bailouts—How We Got Here and What Must Be Done to Fix It'

Here is an excerpt from Mark Zandi's book about the economy and economic recovery.

Much was learned during that trying time, and many financial and economic safeguards were put in place to prevent such an occurrence from ever happening again. The Federal Reserve now knows that it must take extraordinary steps to forestall a deflationary cycle—in which falling prices and wages force businesses and households to pull back, causing prices and wages to fall even more—even printing trillions in dollars to buy those things no one else can or is willing to. Policymakers also know that putting up trade barriers and engaging in financial protectionism such as restricting cross-border investments result in the global tit-for-tat that undermines economies even more.

Many of the safeguards put in place during the Great Depression are working admirably now. The FDIC was born out of the ashes of the thousands of Depression-era bank failures, and the FDIC has forestalled bank runs and major failures during the crisis. Unemployed workers are getting unemployment insurance benefits, food stamps, and soon even COBRA payments to pay for their health insurance so that they don’t panic (along with everyone else they know) because of their lost job. The unemployment insurance system was erected in response to the Great Depression.

The most fundamental lesson of the Great Depression for today’s crisis is that government must be extraordinarily aggressive. In normal times, government must be strong, but little seen; in times of crisis, it must be overwhelming and everywhere. Policymakers working fast and taking big steps will make mistakes, even mistakes that can make matters worse. But with consumers, business, bankers and investors panicked and pulling back, only government has the resources and the will to fill the resulting void.

Policymakers in the current crisis were slow to heed this lesson but have grown increasingly bold. Their actions now have become increasingly unconventional and even unprecedented. Yet their best efforts have not been able to end the turmoil—far from it. A prudent approach thus dictates that policymakers plan as if their current efforts will be insufficient to the task ahead and prepare for what to do next. ...

Another round of fiscal stimulus seems like a real possibility. The $100 billion in tax rebates mailed in summer 2008 proved less potent than hoped because much of the money was used to pay for record-high gas prices. The $800 billion stimulus that began working its way into the economy in spring 2009 might also not provide the economic pop needed. Although it’s big, it’s not big enough. The money will be spread out over more than two years, and the economy’s problems have gotten worse since its passage. Stimulus 3, if needed, should be mostly temporary tax cuts. A payroll tax holiday for both employees and employers—say during the first half of 2010—would be especially effective. This would be costly, about $450 billion, but it would be a significant cash infusion for strapped households and small businesses that will be out of cash by then. Temporary tax cuts don’t provide the same boost to jobs as, say, infrastructure spending, but the money can get into the economy much more quickly.

Excerpted from Financial Shock: Global Panic and Government Bailouts—How We Got Here and What Must Be Done to Fix It. Used by permission of FT Press, an imprint of Pearson.

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