Basically, there are two sides to this debate: One is that the meltdown either exposed or created an economy where the level of unemployment is simply much higher. That is to say, it’s not just the recession pushing unemployment up, but the new reality of a post-high consumption, post-housing boom, or post-something else America.
Romer’s view is different: “This rise in long-term unemployment is readily explained by the prolonged collapse in aggregate demand.” She sees five factors pushing down demand: Tight credit markets, state and local budget problems, burnt-out consumers, subdued foreign demand, and the Federal Reserve’s inability to stimulate the economy by further cutting interest rates.
The neat thing about a demand-side explanation is that policy can help.
My concern is that we instinctively favor the demand-side explanation precisely because it implies that certain relatively popular and thus easy-to-pursue policies can help. The alternative explanation doesn’t necessarily entail accepting a permanently higher level of unemployment. Rather, it suggests that we need to pursue a different mix of policies — relatively less-popular and thus harder-to-pursue, but possibly far more effective at curing the real disease. This is the implication of Tyler’s postscript:
I sometimes have the feeling that commentators on the left reject the “real shocks” hypothesis because they think it implies government can’t do much to make things better. That doesn’t follow. Most of what government does, for better or worse, is an attempt to solve a real rather than a nominal problem. It might imply “intervention is less effective” but it also (possibly) can imply “intervention is more necessary.”
But we can be more explicit: we need to balance the budget over the business cycle, we need to cut spending aggressively, we might need to shift from income taxes to consumption taxes, and most importantly we need to resist the temptation to subsidize fading firms so that we can allow new firms to flourish. This is an activist agenda, only the activism cuts in a different direction.