Dean Baker on the Crisis

Episode Summary

Executive Summary: Dean Baker argues the U.S. economy’s long stagnation stemmed from weaker wage growth relative to productivity, caused partly by declining union power and globalization, and that demand shortfalls were repeatedly masked by bubbles in stocks and housing. He blames the Fed for tolerating bubbles, criticizes 2008 bailouts as protecting banks without reform, and says the 2009 stimulus helped but was far too small.

Main Topics: Long-run wage stagnation and demand shortfall (Priority: 5/5): Baker says the economy broke in the 1980s when most workers’ wages stopped rising with productivity, reducing broad demand and setting up reliance on bubbles. Union decline and bargaining power (Priority: 4/5): He argues weakening unions and the post-Patco willingness of employers to hire replacement workers reduced labor’s bargaining power and helped drive wage decoupling. Asset bubbles as demand replacement (Priority: 5/5): He frames the stock bubble of the 1990s and housing bubble of the 2000s as filling the demand gap left by stagnant wages, until their collapse triggered recession. Federal Reserve policy and institutional structure (Priority: 5/5): Baker faults the Fed for allowing bubbles to grow and says its governance is abominable because industry-regulated members help appoint monetary policymakers. 2008 financial crisis response and bank bailouts (Priority: 5/5): He gives policymakers a low grade for preventing collapse but preserving the existing banking leadership and socializing losses without restructuring insolvent institutions. 2009 stimulus: useful but too small (Priority: 4/5): He supports the stimulus as effective in creating jobs, but says it was insufficient in size and duration and was weakened by premature deficit-reduction messaging. Health care costs and long-run fiscal risk (Priority: 3/5): Baker says the main long-term fiscal problem is runaway health-care costs, not near-term deficits, and favors more market-like competition across national systems.

Key Arguments: Workers’ wages stopped keeping pace with productivity in the 1980s and 1990s, so consumer demand weakened and the economy increasingly depended on bubbles to sustain growth. Union decline mattered not just because unionization fell, but because employers gained a new threat: firing strikers and hiring replacements after the PATCO strike. Stock and housing bubbles were not inevitable; Baker says the Fed had the tools to restrain them but chose not to, especially under Greenspan. After the stock bubble burst, low interest rates and a sense that housing was ‘safe’ helped create an even larger housing bubble. The Fed’s structure is fundamentally flawed because regulated industry representatives influence monetary policy, creating capture risks. The 2008 rescue avoided systemic collapse, but it protected banks and executives instead of forcing losses, replacements, or downsizing. He argues the bailouts were often justified using unrealistic counterfactuals that assumed no policy response after a failure, which he считает intellectually sloppy. The 2009 stimulus created jobs, but it was too small relative to the magnitude of the collapse in private demand and was shortened too soon. State and local aid likely preserved jobs, while tax rebates had weaker effects; direct spending was a mixed bag but still preferable to doing nothing. Near-term deficit fears should not block stimulus because the bigger fiscal threat is long-run health-care inflation, not immediate debt service. A better solution to the health-care problem would be to introduce more cross-border competition and allow Americans to buy lower-cost care abroad, keeping part of the savings. Financial reform should focus on reducing the size and power of big banks through breakup, taxes on transactions, and a functional separation of insured banking from risk-taking.

Data Points: Annual demand shortfall from lost housing construction: around 4 percentage points of GDP, about $600 billion a year - Baker’s estimate of the direct hit from the collapse in residential construction Housing bubble wealth at peak: around $8 trillion - He uses this to explain the collapse in consumption after the bubble burst Annual demand loss from higher saving after bubble collapse: around $500 billion a year - He links reduced housing wealth to a higher savings rate and lower consumption Total annual demand shortfall after the housing and nonresidential bubble collapse: probably over $1.2 trillion - Baker’s estimate of the aggregate demand gap the private sector could not fill Stimulus package size: $787 billion, later measured as $825 billion - The American Recovery and Reinvestment Act discussed in the interview Stimulus actually functioning as demand support: around $300 billion a year in 2009–2010 - Baker’s estimate of the timing and scale of effective stimulus spending Jobs created by stimulus: 2 to 3 million jobs - His estimate of the employment impact of the 2009 stimulus Jobs originally projected by Obama administration: 3 to 4 million jobs - What the administration expected if it received the full requested package Potential needed jobs to restore full employment: 10 to 12 million jobs - Baker’s estimate of the scale required to close the recessionary gap Private savings rate at bubble peak: pretty much zero - He contrasts this with the post-bubble rise in saving Private savings rate after bubble collapse: over 5% - Used to estimate reduced consumption demand Federal funds rate peak and cuts: raised to 6% in 1994–95, then lowered to 1% after the stock bubble burst - Baker cites these rate changes in discussing Fed policy and bubble formation Health-care spending per person: more than twice as much as other wealthy countries - He cites this as the main long-run fiscal issue for the U.S. FDICIA-era systemic response example: one major case noted; WAMU or Wachovia went through the FDIC - Used to contrast selective loss-bearing with broad bailout protection Unemployment among construction workers: around 20% - He cites high construction unemployment as evidence that stimulus-related construction could absorb labor

Pivotal Quotes: "the Fed had all the tools that needed to prevent this disaster" — Dean Baker: His criticism of the Federal Reserve’s failure to restrain the stock and housing bubbles "I would say give them a D" — Dean Baker: His grade for policymakers’ handling of the 2008 financial crisis and bank rescues "We have a broken health care system" — Dean Baker: His explanation of the main long-run fiscal problem facing the United States

Implications: Baker’s view implies that preventing future crises requires stronger wage growth, tougher anti-bubble monetary policy, bank downsizing, and more aggressive fiscal support in downturns. He sees long-run budget stability as inseparable from health-care reform, not austerity.