While the right wing is busy spreading FUD about the economy and the Democrats’ fiscal stimulus (thereby openly opposing schools and teachers, bridges and railroads, alternative energy and environmental protection, Food Stamps and social services), and disseminating outright misinformation about what worked in the Great Depression… most of us are just struggling to keep up with the flood of bad news the meltdown keeps producing and hoping that the next shoe to drop, won’t drop on our own personal heads.

Record low housing starts, skyrocketing unemployment, new proposals to mitigate foreclosures, uncomfortably familiar proposals about getting bank balance sheets sorted out… I’ve tried my level best to delve into the details of all this over the last few months, but sometimes you feel like you have to be glued to the news just to keep up with what’s happening, and be a professional economist just to understand it.

As it happens, though, amidst all the media hubbub, a site has emerged out there that’s doing a sterling job of keeping track of all this and explaining it in terms that laymen can understand. Founded by a diverse trio of experts just five months ago, The Baseline Scenario has been hailed by the likes of Bill Moyers and Paul Krugman, and cited by everyone from The Wall Street Journal to The Financial Times to The Guardian.

What it offers are works of opinion (what isn’t, these days?)—but it’s carefully sourced, logically structured, soundly argued, and (importantly) easy for non-experts to follow. (While I admire Nouriel Roubini’s RGE Monitor, this site is a bit more user-friendly.) The site has an excellent page laying out “The Financial Crisis for Beginners”… and of particular note in regard to this week’s goings-on among policymakers, it has this to say:

The world is heading into a severe slump, with declining output in the near term and no clear turnaround in sight. We forecast a contraction of minus 1 percent in the world economy in 2009 (on a Q4-to-Q4 basis), making this by far the worst year for the global economy since the Great Depression. …

There are three major categories of potential policy responses: fiscal, financial, and monetary. However, each of them faces real constraints.

First, a substantial fiscal stimulus is already in train. The constraints on this dimension are, first, the ability of the Republican opposition to block legislation in the Senate and, second, the US balance sheet. The US balance sheet is strong relative to most other industrialized countries – private sector holdings of government debt are around 40% of GDP.  But the US authorities also have to worry about increasing Social Security and Medicare payments in the medium term, and so are reluctant to accumulate too much debt.  The underlying problem is that fiscal policy was not sufficiently counter-cyclical during the boom. The federal fiscal stimulus will be helpful, but it will not be enough to prevent a substantial decline or quickly turn around the economy.

We’re supportive of the fiscal stimulus, at the currently proposed level, and we also strongly support the view that cleaning up the banking system properly will add further to our national debt – probably in the region of 10-20% of GDP, when all is said and done. (While this seems like a lot, Linda Bilmes and Nobel Laureate Joseph Stiglitz have estimated the long-term cost of the Iraq War at $3 trillion which, although this may be on the high end, is over 20% of GDP.) And we further agree that some form of housing refinance program will help slow foreclosures, and this should further increase the chances that the financial system stabilizes.

But all of this adds up. US government debt held by the private sector will probably rise, as a percentage of GDP, from around 41% to somewhere above 70%.  This is still manageable, but it should concentrate our minds – we do not agree that the impact of the fiscal stimulus will be adverse, but we agree the US government fiscal position could become more precarious down the road. …

Second, financial sector policy has not been encouraging. Despite a series of efforts that were both heroic and chaotic, the banking sector today is roughly in the same state it was in after the collapse of Lehman in September: investors do not trust bank balance sheets, further writedowns are expected, and stock prices are above zero mainly because of the option value of a successful government rescue. …

Our baseline view is that the government launches a medium-scale bank recapitalization and balance sheet clean-up scheme.  This will not be enough to really turn around the situation in US banking.  But it could temporarily bolster confidence in the US banking system, causing a rise in equity prices for banks (as the market expects more government subsidies) and – most important – a strengthening of debt, both for banks and perhaps for leading nonbank corporates. …

Third, monetary policy can still make a difference. In particular, we risk entering a deflationary spiral with falling prices and downward pressure on nominal wages. The inflation swap market currently implies minus 0.3% average annual inflation for the next two years (although the five-year expectation is for inflation at 1.5% per year). Deflation is not yet completely entrenched, so it is still possible to turn the situation around. However, the Fed has not yet settled on the view that deflation is the main issue, and there is no internal consensus in favor of printing money (or focusing on increasing the monetary base).

It’s not a rosy analysis, but it’s honest and serious. And like any good blog, it has an open comments section as well… which in this case is populated by some genuinely thoughtful folks. While there may not be any take on today’s economic situation that you can (ahem) take to the bank, this one is at least deserving of some attentive reading.

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