The Big Question: What’s Holding Back the US Economy?

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Hal Weitzman: Corporations are flush with cash. Businesses are hiring. Interest rates are at historic lows. And the housing market appears to be recovering. So why isn’t the US economy growing faster?

Welcome to The Big Question, a new monthly video series from Capital Ideas at Chicago Booth.

I’m Hal Weitzman, and for Part Two of our launch edition, I’m joined by a trio of Booth’s finest.

John Cochrane is the AQR Capital Management Distinguished Service Professor of Finance at Chicago Booth. He’s a research associate of the National Bureau of Economic Research, a senior fellow of the Hoover Institution, an adjunct scholar at the Cato Institute, and a past president and fellow of the American Finance Association. He blogs at the Grumpy Economist.

Amir Sufi is professor of finance at Chicago Booth. He’s also a research associate at the NBER and the recipient of an Alfred P. Sloan Research Fellowship.

And Steven Davis is the William H. Abbott Professor of International Business and Economics and deputy dean for faculty at Chicago Booth. He, too, is a research associate with the NBER, an economic adviser to the US Congressional Budget Office, a visiting scholar at the Federal Reserve Bank of Philadelphia, and a nonresident visiting scholar at the American Enterprise Institute.

Panel, welcome to The Big Question.

Steve Davis, let me start with you, because a lot of your research has been about the relationship between policy uncertainty and economic growth. And this is likely to be a year in which there is a considerable amount of policy uncertainty. What’s the dynamic there?

Steve Davis: Yeah, I think it’s a complicated one. There’s multiple aspects. Maybe that’s easiest to see with some examples. So think about what’s happened just recently. We had a big fight over the fiscal cliff. We had a big fight in summer of 2011 over raising the debt ceiling. We might go through that fight again.

The element that’s common to those fights is sort of a policy uncertainty manufactured by the political process itself. You might think about it as a self-inflicted wound.

Now that’s very different from some other episodes of policy uncertainty. So I’ll go back to the financial crisis. After the failure of Lehman Brothers in September 2008, there was a lot of policy uncertainty because the economy had just been hit by huge shock. Policy makers were faced with difficult challenges. It wasn’t clear what they should do or what the consequences would be.

Yet another example that presents kind of a different aspect of policy uncertainty is the immediate aftermath of the 9/11 terrorist attack. And unlike the other examples I talked about, this is clearly something that for most of us originated out of the blue from outside the normal workings of the political and economic processes.

So these are quite different in terms of the origination of these shocks and the role in which the policy process itself is responsible. But regardless of where the shock originates from, high levels of uncertainty, whether they stem from policy or otherwise, tend to discourage spending and investment by businesses and households, slow hiring, they make it harder to plan, and just tend to be a damper on economic performance.

Hal Weitzman: John Cochrane.

John Cochrane: Steve has done some very good work on policy uncertainty. And I think that was a big problem in the past. I also think that a country that decides its tax code once a year in the middle of the night in a lobbyist heaven is—

Hal Weitzman: You’re referring to the fiscal-cliff deal?

John Cochrane: And not just this fiscal cliff, but then the previous debt-ceiling limit. The one we’re gonna have next month. It is a charade that we do this.

But my worry is that we are now heading into a new era where we know with great certainty that we’re gonna have the wrong policies. And that our problem now is one of long-run growth, a new normal of slow growth rather than temporary recession. And that that might be even worse than the uncertainty that Steve documented very well.

Steve Davis: Let me pick up on one aspect of what John says, and something that I worry about a lot, and what I don’t think gets enough attention in the press.

Now, there was an extraordinary drop in the share of adult Americans who were working during the financial crisis. It dropped by about four percentage points, starting from 63 percent. That’s an enormous drop, unlike anything else we’ve had in the past 65 years.

And here’s what’s not appreciated. There’s been essentially no recovery of that. So the modest job growth we’ve had has just been barely enough to keep up with population growth. Now, that plays into John’s point, because these are people who are in all likelihood not coming back to gainful employment anytime soon and will contribute to lower GDP, lower income than we would have otherwise, and presents very challenging policy problems as to: How do we bring these people back into the workforce?

Hal Weitzman: Amir Sufi.

Amir Sufi: I think we need to appreciate the massive shock to the economy that we had, from 2007 to 2009 especially. And any time you get a massive shock like that, the economy needs to be able to reallocate resources: labor, capital. We need to shift from, for example, building too many homes to doing whatever the next productive thing is.

And what you need in that circumstance is a nimble government to come in and, to the degree it can, facilitate that reallocative process. And that requires some very sensible policy making, that requires a system that actually can adjust to whatever shocks are being received.

And I think that Steve’s research highlights one particular aspect in which the government is not at all facilitating, in fact may be hindering the natural reallocative process. I tend to agree with John that in the long run, there are these major issues: Medicare, spending. These are issues that definitely need to be addressed.

I have been more of the opinion that there are limited government interventions that could have facilitated the response to the recession.

For example, helping to restructure mortgage debt, helping to facilitate the recovery in the housing sector.

But that does require a very nimble government that can come in and very quickly facilitate things rather than acting as kind of a roadblock, which I think Steve’s research on policy uncertainty certainly shows is happening.

Hal Weitzman: And so, what has happened in the absence of that nimbleness?

Amir Sufi: I think things like the fiscal cliff. Things like the debt-ceiling debate in 2011. For no doubt, if we believe that one of the problems with the economy is that we need to shift resources from, for example, households spending like crazy out of home-equity wealth, to businesses investing, for example, for export in related industries, businesses need an environment in which they can kind of be comfortable shifting those resources.

And I don’t think that having fiscal-cliff debates, having debt ceilings, having government policy, as John said, done in the middle of the night on New Year’s Eve or New Year’s Day even, that certainly is not going to be able to facilitate that reallocative process.

Hal Weitzman: John Cochrane, even if we were able to get all the politics right, exactly as we want them. What would some of the other challenges be for the US economy?

John Cochrane: Well, I was gonna say, getting out of the way is the first thing the government could do. I do think it is time to think about the long run. This is often framed as if we are an economy that can grow well, provide more jobs, really provide prosperity with some sort of temporary problem.

And I think we’re, after four years now—and a not very good previous decade—we’re heading to the point that we should worry very much that the US economy is headed for a decade of 1.5 to 2 percent very slow growth, yery high permanent unemployment, a lot of sand in the gears, a lot of overregulation, which I think is stifling a lot of growth, a lot of crony capitalism, where everybody goes to Washington to get their special deal, as opposed to build a new factory that can export. And that getting this long run right is something we know how to do, and it’s probably more important now than the latest band-aid fix or big policy to stimulate demand in the short run.

Hal Weitzman: Amir, a lot of your research has been on household debt. So talk about consumer demand. What’s the dynamic there? How is that playing out?

Amir Sufi: Right, so this is the argument, and I think it’s very important to have the right economic framework in mind, because I think as John would definitely tell you, and I think most macroeconomists would tell you, the notion that demand is constraining economic output is not a very standard notion in most macroeconomic research.

So in my research, we basically have to take the stand that in this very temporary period, we may be undergoing a situation in which the economy becomes demand constrained. It’s a very Keynesian argument that comes out of the notion that there may be some friction that prevents the economy from reallocating resources. And the one that is most typically relied upon, which is quite technical but is the zero lower bound on nominal interest rates. It’s the notion that interest rates, the real interest rate can’t get low enough to actually induce savers or businesses to invest as much as they should.

I’m becoming a little bit more skeptical over time whether that’s the main friction. But I definitely believed from 2007 to 2009, kind of the heart of the Great Recession, that there was this Keynesian friction present. Now, the solution in the face of that Keynesian solution is not so obvious. A lot of people say, well, the government should go out and spend in that demand-constrained setting. My view is that that can be potentially dangerous in the long run too, because if the household sector had a big debt problem, that’s not gonna be solved if the government then has a big debt problem.

So our research basically made the argument that we should facilitate the restructuring process in the household sector, which in that time period could have basically helped to help the economy. Now, the key question, I think the question that’s very difficult to figure out is: Where are we past that cyclical friction and where are we looking at the long-run problems that I think John’s highlighting: employment problems, long-run social security, long-run Medicare? And given the recent recovery in the housing sector, my view is that there is still quite a bit of a role of the government to, for example, facilitate refinancing for underwater homeowners—a policy which, by the way, Glenn Hubbard, Mitt Romney’s campaign adviser, supported, and people on the left support as well.

Hal Weitzman: John Cochrane, is this a demand issue?

John Cochrane: I wanna not quite challenge, but point out one of the tensions here. So as Amir pointed out, there’s a desire for Americans to deleverage. to pay down some of their debt, to start saving again, which Americans notoriously didn’t. But of course the Keynesian solution says, no no, we don’t want you saving. We want you to consume.

So we want people to simultaneously start saving more and investing more. We also want them to consume more and we want them to pay more taxes. And I’m sorry, you can’t have all three together. I mean, just let’s start with a basic question. Do we want Americans to start saving and investing and paying down their mortgages? Or do we want them all to be taking out lots more debt and consuming? Well, this sort of Keynesian economics doesn’t know which one of them it wants. It wants both, which you can’t do.

Steve Davis: I wanted to jump in and actually play off some of the previous comments by both John and Amir about the longer-term issues we face because I think both of you have stressed that. I thoroughly share that view. And I just wanna point out a couple of things. Amir mentioned the need to reallocate resources away from an overbuilt real-estate and housing sector into other sectors, and so on.

There’s a fairly sizable body of literature in economics that shows, in my view fairly persuasively, that much of the medium-term growth in the United States and other economies comes about through the process of reallocating resources to more productive facilities and uses. And to the extent that that’s been harmed, either by financial frictions or regulations that are adding roadblocks to that process, that is a source of concern about the long-term productivity growth of the economy. And that’s one reason I share John’s view.

My point earlier about the collapse of the employment rate and the failure to recover I take as another symptom of these longer-term problems.

We have this notion in the United States that while we’ve tended to grow at 2.5 or 3 percent for ever since the Civil War—we’ve had some major blips, the Great Depression being the worst—but there’s this steady upward drift of 3 percent or so a year, on average. But if you look around the world, you can see some pretty clear counterexamples to the notion that just because an economy has always grown, it’s gonna continue to grow. One of the most dramatic is Japan, which had growth rates very sharply outpacing the United States until 1990, and then since then has grown at very anemic rates.

Hal Weitzman: Should we just expect sluggish growth?

Steve Davis: No, I’m not saying we should expect it, but I’m endorsing John’s view that there are reasons to be concerned. If we put in the wrong set of policies, we may never return, or not anytime soon, to the kinds of growth rates that we’ve become accustomed to since World War II and even earlier in the United States.

Hal Weitzman: But what you’re suggesting is it almost goes beyond politics. Even if we got the policies right, there would still be considerable problems.

Steve Davis: No—

John Cochrane: Well, politics and policies can help a lot. Long-run growth in the end does not come from stimulus projects or one program or another. Long-run growth comes from new ideas, greater productivity, doing more stuff with the same people, new ideas incorporating new products, new businesses, new ways of doing things.

What that takes is the capacity of an economy to innovate, to take those new ideas, to start those new companies, which means you have to get the rewards from the new companies.

The US right now, our scientific and technical capabilities are enormous. Just read any science magazine. There’s all sorts of great new ideas out there. The problem is gonna be getting those into new businesses. Those new businesses have to disrupt and challenge the profits of old businesses. And we need to have more Silicon Valleys emerge, not more “go to Washington and get your special deal” emerge. I think our danger right now is we’ve become a very stratified, very static society, where we fight over the zero sum game in Washington and kill that golden goose of growth.

Amir Sufi: So I’m certainly not gonna disagree with John on that. Clearly there are some serious problems in Washington, DC. But one of the things I wanna emphasize is I don’t think naturally that these two goals are mutually exclusive.

I think when we look at what happened in the Great Recession, we see unemployment rates shoot above 10 percent. We see 6, 7 million jobs lost. These are clearly cyclical phenomena. I think we have to all basically be willing to admit, there must be some frictions that in the short run are hurting the reallocative process of the economy.

I’m not here trying to tell you, well, we need consumers to start spending again, or we need the government to spend. But there are tangible things that in a cyclical sense the government could have done to help facilitate the process of that reallocation.

Let me give a very simple example. They say one in four homeowners in this country are underwater on their mortgage. It’s almost impossible to imagine that that’s not having a distortive effect on the economy. So there may be some role, if the private sector can’t officially restructure mortgages, for the government to step in. Now, again, I don’t view that reallocation function as being mutually exclusive from the long-run goals. I completely agree with Steve and John that in that reallocative process, that if the government is going to take a role—

Hal Weitzman: So you’re talking about smoothing it—

Amir Sufi: Right. We shouldn’t distort the long-run incentives. I completely agree with that. And that’s the tricky balance that you have to try to take on as a government.

The last thing I’d like to say on this topic, though, is I think that I’ve been very interested, and I’ll pose it as a question about whether we think these structural reforms, or these reallocations to the long run, to the more efficient, is that best to take place in a situation now where we have sustained, very long-run unemployment? Or is it better to wait until maybe we can get some slight recovery and then take on those issues?

Again, I’m raising it as a question. I don’t think it’s so obvious that people say, oh, Greece is in such big trouble. It’s the perfect time to do structural reforms. At some point, maybe you push too hard on that dimension and you end up backfiring and getting worse outcomes than what you want.

Hal Weitzman: John Cochrane.

John Cochrane: Well, so a little view into the faculty lunchroom. So this idea that mortgage relief is a great one, right. So I don’t wanna argue yes or no, but there is an argument on the other side. And so this is how we typically fight it out at lunch. Gee, it would be great if we could just have taxpayers forgive all those underwater mortgages. Then those people could move and get new jobs, and life would be great. But, says the curmudgeon on the other side, wait a minute, that’s grossly unfair. And if you get in the habit of forgiving the old mortgages, then you set into place all sorts of awful incentives for next time around. Who’s gonna make mortgages knowing that the government might take them back? Who’s going to take a mortgage on a smaller house rather than a bigger house, knowing if things go wrong, he has a good chance of the government taking it back. It sounds curmudgeonly. This isn’t the point to say one side versus another, but there’s always the short-run benefit, long-run loss, which is what we as economists think about.

Amir Sufi: Right, for sure. And I wouldn’t disagree with a lot of those comments. I think that, look, I’m a big believer that debt has good incentive provision aspects and that debt helps to get people to behave in a way that we think is right. But I do think when we get a shock of house prices falling 30 percent nationally, at that point, there may be some role, targeted . . . and I wanna be clear. In fact, I actually think sometimes if you actually forgive principle, you can actually get people out of homes that they shouldn’t be living in.

So for example, there could be a household of four now living in a $500,000 home that they clearly cannot afford. But they can’t move because if they move without having the foreclosure happen, they have to bring cash to closing. So you could actually facilitate that reallocative process and make everybody better off. And I think there is quite a bit of evidence that there are actual market frictions that are preventing mortgage renegotiation.

Steve Davis: They’ve done a nice job of fleshing out the short-run and long-run benefits. I just had one point, that there’s also the big challenge of getting the government to implement these kinds of policies in a way that does justice to the short-run and long-run trade-offs that we’ve been talking about.

That may be the biggest challenge of all. So these guys can design a good policy, getting that through the legislature, in something like the form it was envisioned, and having it function the way it was envisioned, that’s an enormous challenge.

John Cochrane: Especially when we’re setting up the incentives for next time.

But I wanted to spark a discussion here, because we brought up employment, and you guys are both the experts on this. We brought up one thing, which is people stuck in their houses, can’t move to a better state, can’t leave Detroit and go to somewhere where there’s more jobs. And you were saying, perhaps the government should help that.

On the other hand, there’s been a lot of criticism of social programs, especially social-security disability, freezing people and not letting them go to where the better jobs are.

Our colleague Casey Mulligan wrote a whole book about that stuff. And you’re sort of the expert on reallocation. So as you guys look at the labor market, the companies who say they can’t get workers, the people who say they can’t get jobs, we know it’s not just more demand, more jobs being offered. It’s better matching. Where do you see the big frictions right now?

Steve Davis: Let me point to several. And I think it is a combination of cyclical and longer-term forces. And they’ve actually interacted in a somewhat unfortunate way recently.

You mentioned disability insurance. That’s a big problem. Expanding disability roles over time in the United States, long preceding the recession, despite the fact that jobs have become less physically demanding. And that’s because we’ve loosened the eligibility requirements and we’ve gravitated a bit in the last few years toward relying on disability insurance as a secondary unemployment system. And the problem, as you suggested, is disability insurance in this country as it’s worked out is a one-way street. Once you qualify for social-security disability, people almost never come back to work. So that is an issue. There are many others.

We do a miserable job of educating many folks in our public-school systems—not all, but in many cases. We’ve got declining employment rates among less-educated men for quite some time.

Our colleague Erik Hurst has done some nice work recently—it’s actually work still in progress—showing that the construction boom before the recession kind of masked an underlying long-term decline for the kinds of skills that less-educated men had to supply. That’s mostly coming from the decline of manufacturing.

We haven’t done a very good job of figuring out how to provide other forms of gainful employment for those folks. We put an enormous number of people through our penal system. Some extraordinary number of less-educated men have had contact, often time in prison. Once you’ve had that kind of experience, it’s very hard to get on. It’s very hard to find what we think of as a good job.

So there’s a variety of these longer-term issues that interacted in a particularly negative way, as I suggested earlier, with the cyclical downturn. And many of these problems, even if we took the right policy steps today, are going to take a generation to fully work our way out of them.

I’m very worried about these problems.

Amir Sufi: Yeah. So I think, consistent with what Steve’s saying, I think one of the pieces of research I’ve worked on is to try to basically show that in the short run, I do think a lot of the jobs were lost because of the shock to household spending that came from the disaster in the housing market. And one of the things that’s been very interesting as we kind of update the data to look past 2009 is that in a lot of these very hard hit housing markets, for example, Northern California, the Central Valley, complete disaster—unemployment rates through the roof—that we have not seen, first, anybody move out of these areas. That’s what’s shocking. No one’s moving out of these areas.

Second, wages aren’t going down, which is the natural resource allocation you think would happen. And then you do have to start to ask serious questions about what is wrong with the reallocative process that it’s not allowing these people to go find jobs, either moving out.

I think the best piece of research that I’ve seen on this question is this paper by David Autor and Mark Duggan on disability that basically says something that’s a little bit more subtle than the Casey Mulligan argument. And that is: people don’t quit their jobs to get on disability. They lose their jobs because of some shock and then they became less likely to look for jobs because they can get disability.

The big question for me . . . Casey’s research I think still more is driven simply by his theoretical priors. I wanna see very hardcore evidence. I think it probably is true that at the margin these social programs are inhibiting the reallocative process. Researchers tend to be a little slow, unfortunately. Maybe we do things more carefully than everybody else. But I’m waiting for the paper that really convincingly shows me this.

Hal Weitzman: Well, what about the employer perspective? Steve Davis, what will it take to get companies to start hiring again, putting those big corporate cash piles to use?

Steve Davis: That’s a question that I’m not terribly fond of, because obviously from the level of an individual employer, well, if they see higher demand for their sales, they’re gonna start producing more, hiring more workers, and so on. But it doesn’t really answer the larger question, which is: Where does that demand come from? And we’ve been talking about many of these issues.

And there’s a separate set of issues about, well, where do they find the workers that they would want when they expand? So I kinda like to step back and say, well, what are the factors that are inhibiting the demand for the employers’ product?

What are the factors that are making some workers either not very attractive as employees because they’ve spent time in the prison system, they didn’t get a good education, whatever. Or, perhaps the Casey Mulligan thesis: we’ve made not working sufficiently attractive for a large number of our potential workers that they’d rather not work.

Amir Sufi: I will jump in on that point just to say that the huge cash balances at corporations very closely mimics also the saving decisions of very high-net-worth individuals, which is also tremendously allocated toward cash as well.

And I know that this is a very Keynesian friction. There can be some standard money demand reasons why. But it does look like there seems to be some kind of excessive demand for liquidity across the economy. And I’m sure John will have a lot to say on that. But it’s something that I think we do need to grapple with. And does seem like a cyclical tension rather than a long-term structural issue.

John Cochrane: We’re just following the money demand curve. When interest rates are zero, there’s no cost to holding a lot of extra cash. And I actually think the money demand curve is pretty much what it always has been, just right out to the low interest-rate part. This is actually an unheralded and wonderful thing about the current environment that rather than the high-tech finance, overnight repo, clever stuff that all fell apart, companies can now, at zero interest rates, just hold a lot of cash. And there’s that nice cash buffer. They’re not losing any interest from doing it.

We shouldn’t regard this as something unusual and that cash being not put to work or something of the sort. It’s a perfectly natural portfolio decision when interest rates are zero and there’s no cost to doing it.

What I do wanna point out from what you just heard here, the way you asked the question and the answer is very revealing. The common perception is that employment is just: we need more jobs. Companies need to give more jobs. Well, employment is a match. It’s a match between people and jobs. Most people who are unemployed right now could go to Walmart tomorrow and start. They don’t want to. And they shouldn’t. That’s not the best use of their talents.

China doesn’t have 900 billion more jobs than we do, because they have more businesses offering them. They have more people. Jobs are a match of people with skills and desires and what they want to do. There’s a lot of sand in the gears there. And it’s a much more nuanced question than just, let’s get the employers to give them more jobs.

Hal Weitzman: What about the . . .I wanna turn to the international picture, because we talked about the US almost exclusively. But all the turmoil that’s happening in Europe, for example, the slowdown in emerging markets. How does that affect what’s happening in the US economy? John Cochrane, I’ll start with you.

John Cochrane: Well, the obvious . . . there’s linkages through trade, which are fairly obvious. Europe is sitting on a powder keg of what’s going to erupt next from the looming sovereign defaults of the south.

And for the moment that is papered over by the European Central Bank buying up everything in sight. But that isn’t a long-term structural solution. So I think we’re waiting for the explosion from Europe, and heaven knows what will happen then.

Hal Weitzman: And how damaging will that be to the US, Amir?

Amir Sufi: Well, my view has always been that, basically, since the collapse of the housing market in the financial crisis, there is a pretty substantial part of the US economy that’s just sitting it out in the sense that they’re trying to recover their balance sheets. Many of them are moving. A lot of them are having a hard time finding jobs. And that any shocks that come from overseas in Europe, because we’re relying on a kind of a subset of the population that really is having kind of a functioning normal economy, those shocks end up basically worrying— through the uncertainty channels, through the standard channels of precautionary savings—they end up worrying that substantially smaller fraction of the US population.

So the example of the tsunami in Japan. The tsunami in Japan, normally, the actual linkages seem quite small. It did look like it had a blip and actually affected some of the production chains and some of the demand in this country. So this is kind of my perception is that even if Europe . . . the trade links, I think, are actually not as strong as many think they are, that somehow, oh, if they have a financial crisis in Europe, that’s gonna affect exports of the US to Europe. But I think it’s more through these channels of what are people’s perceptions of where the economy is going, especially given that we have midnight deals in Washington, DC, and so much other uncertainty. It just adds another thing to the fire.

Steve Davis: I agree that the trade linkage is a modest one. The bad economic conditions in Europe is a negative for the US, but I don’t think it’s been a huge one thus far. I agree with John. The European debt situation is a powder keg. I’m less convinced than John is. I think that it will eventually blow up. I think there’s a good chance the Europeans will paper it over long enough and work their way out of it at considerable cost to them without, say, a systemic failure in the financial system.

That I think does have potential to spill over to the United States in a very negative way. Although my understanding of the facts is that US financial institutions have become much less exposed to weak European sovereigns and weak European financial institutions over the past two years.

And so, I think the risk of contagion, of some kind of worldwide or global financial crisis like we had in 2008, early 2009 is considerably reduced. So it may be that even if Europe does implode, have a major systemic financial crisis, that it will have only moderately negative effects on us rather than [inaudible].

Amir Sufi: One of the similarities I find between Europe and the United States that I find it striking is that in both situations, both in 2007 to 2009 in the US and now in Europe, there are these enormous real losses that have to be had on positions, especially on debt positions.

And what we do instead of just realizing those losses, getting over it, and figuring out how we allocate those losses, we call things a liquidity crisis. Oh, it’s just a liquidity crisis. We can just get through it for a little bit. And actually, trying to forestall this process actually ends up being worse than if we just ate the loss right away and we just imposed it on somebody, said you had the loss. I had the loss. Instead, we have the ECB coming in, then creditors are wondering, well, are we prioritized above the ECB?

So this creates a process that to me is just silly. And I think more and more, you see this throughout the world. Whenever there’s a major crisis, economists step in and say, oh, it’s a liquidity crisis. It’s actually not a solvency crisis. It’s never true. It’s always a solvency crisis. We need to impose those losses on somebody. Fine, maybe we shouldn’t impose it on highly leveraged institutions, but we need to think about it, about where it should be imposed.

And getting over that process by just imposing those losses sometimes would be better for everyone than just basically going forward, stumbling forward, and thinking through the issues very slowly.

Hal Weitzman: Just swallow the medicine, John Cochrane.

John Cochrane: The economists are the one saying it’s a solvency crisis. They should default.

Amir Sufi: (laughing) Maybe. Not all economists.

(all laughing)

John Cochrane: It’s the politicians who always say, oh, it’s markets are impaired. It’s liquidity. We just need to paper it over a little longer.

I wanna agree that the European debt crisis is the earthquake fault we’re sitting on, which could explode. It is likely not to. They’re likely to be able to paper it over. And the losses will be taken slowly, bit by bit, with occasional restructurings, long years of poor growth, and quite a bit of inflation eventually, I think.

However, if the earthquake explodes in Europe, I think the contagion—I hate to use that word, but—it won’t be direct. It won’t be because Americans directly are invested in Greece. What it will do is people will wake up and say, wait a minute. Sovereign debt isn’t safe. And gee, how are the US states doing? And why am I invested in 30-year Treasurys? And I think that wake-up call could really shake up the US. But we’re talking about—.

Hal Weitzman: On that extremely somber note, I’m gonna call time. But my thanks to our panel, John Cochrane, Amir Sufi, and Steven Davis.

For more research, analysis, and commentary, visit us online at chicagobooth.edu/capideas.

And join us again next time for another The Big Question.

Goodbye.

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