The Hangover

H appy New Year. About last night . . .

We have, in a way, been here before. The Covid-19 epidemic and the federal response follow a familiar pattern: A crisis emerges, extraordinary action is taken, that extraordinary action acquires interest groups who wish to see it become ordinary action, economic troubles inevitably follow, and sorting it all out gets pretty hairy pretty quickly.

Sometimes, this doesn’t go too badly. Consider the end of World War I, when many progressives desired to keep Woodrow Wilson’s “war socialism” as a permanent practice, giving the federal government broad managerial powers over both the economy and civil society. Washington had got itself a taste of real autocratic power, and wanted more. (Jonah Goldberg describes this seduction very intelligently in Liberal Fascism.) But Americans had had enough of it, and Warren G. Harding put a stop to it with his “Return to Normalcy.” But it wasn’t easy: The U.S. inflation rate had been above 17 percent during the war, and it was still above 15 percent in 1920. But as the United States transitioned from a war economy to a peace economy, there ensued a great deflationary recession, with the high wartime inflation being followed by steep deflation — of nearly 11 percent — in 1921. Discharged soldiers went looking for work in a flooded market, with wages stagnating or declining. The medicine was bitter — in 1921, defense spending was cut by a third and overall federal spending was reduced by 7 percent — but it largely worked, and the rest of the 1920s turned out to be famously prosperous.

The end of World War II came with some economic trouble, too: Dwight Eisenhower was as much of a return-to-normalcy guy as the country could have hoped for — he personified normalcy — but these transitions are never without agony, and the 1958 recession was a serious one.

Lyndon Johnson flooded the economy with money thanks to his two wars — the more expensive one in Vietnam and the less expensive (at the time) one against poverty — which helped to cause the painful inflation that persisted throughout the 1970s and into the first years of Ronald Reagan’s presidency. Reagan had the good sense and patriotism to take a political hit and stick with Paul Volcker’s painful anti-inflation program, and it drove his approval numbers lower than a snake’s belly in a wagon rut. If not for Reagan’s great political skill — and the roaring recovery — pursuing an intelligent anti-inflation policy might have ended his presidency.

Emergency. Emergency spending. Inflation. Recession. Recovery. The pattern is not difficult to discern.

Because our current tribal rage causes us to see everything in the dumbest possible binary terms, it is sometimes difficult to make the case that Covid-19 was a genuine crisis, that it required an extraordinary response, and that, at the same time, the crisis has been exaggerated, the response has overreached and over-persisted, and that an unpleasant process, something like the economic version of drug withdrawal, is now necessary.

The political problem is partly self-correcting. The Covid-19 spending measures were popular because spending is popular categorically. The people who were receiving supplemented and extended unemployment benefits were in themselves a highly motivated constituency working to secure their own benefits. But now that all that spending is supercharging inflation, the wage gains of the past few years are being reversed or entirely erased for many workers, especially those in lower-wage jobs. By some recent measures, real wages — meaning wages adjusted for inflation — are down year-over-year for lower-wage workers. Current policies are, in a measurable way, hurting the people they are meant to help.

This punishes everybody: U.S. productivity has just suffered its biggest decline since 1960.

There is no easy fix. The usual way to put a brake on inflation is to raise interest rates. That is a hard thing to do for the U.S. government, which is the most indebted organization in world history and already spends a substantial share of each year’s tax revenue on interest payments for prior years’ spending. Both the government and the broader economy have become very accustomed to ultra-low interest rates — free money, in effect — and both will have a tough time adapting to a different credit environment.

Prosperity will emerge — if we let it. But first, we have to do the hard part: reforming our public finances with an eye toward long-term stability and following a more sensible long-term monetary policy, thereby creating the conditions of stability and predictability in which sensible and profitable long-term investment is possible.

The hangover is coming. That’s the bad news. The good news is that hangovers end.