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The forest for the trees

Who's handling the economic crisis better -- the US or Europe? Today, New York Times columnist Paul Krugman points out the stark differences in response. His conclusion is that by doing less, Europe is asking for more trouble.

Krugman writes:

Europe has fallen short in terms of both fiscal and monetary policy: it's facing at least as severe a slump as the United States, yet it's doing far less to combat the downturn.... Many economists, myself included, have argued that the Obama administration's stimulus plan is too small, given the depth of the crisis. But America's actions dwarf anything the Europeans are doing.

The difference in monetary policy is equally striking. The European Central Bank has been far less proactive than the Federal Reserve; it has been slow to cut interest rates (it actually raised rates last July), and it has shied away from any strong measures to unfreeze credit markets.

I found another viewpoint in of all places, a real estate blog. The author says the Federal Reserve could learn a thing or two from the US Forest Service. For decades, the Forest Service policy used to be: put all fires out quickly. Don't let anything burn. Protect as many trees as possible for timber production:

To its chagrin, the US Forest Service discovered its policy was flawed. By not allowing small fires to burn, leaf litter and other combustible natural growth accumulated. In unmanaged forests, periodic fires eliminate this source of fire fuel. In managed forests this accumulation of fuel fosters fires that get out of control.

The Forest Service changed its policy and allowed smaller fires to burn. The article continues:

Just like the accumulation of fire fuel on the forest floor, our economy accumulates unsound business plans, Ponzi Scheme financing arrangements, idiotic investment strategies, and behavioral moral hazards. Recessions are supposed to be the small fires that destroy these destructive agents, but when the Federal Reserve manipulates interest rates and stimulates the economy, recessions are not allowed to serve their purpose, and the economic problems pile up.

Obviously, this about the Fed's policies over time, not just the crisis management mode we're in now. But it does relate to the issue of doing something versus doing nothing. At what point does manipulation of the economy backfire? The Fed shouldn't shoulder all the blame for this economic implosion, but it's certainly worth discussing how much is too much and in Europe's case, whether less is sometimes more.

It's hard to believe we're talking about Europe being more laissez-faire than the US. But here we are. On the other side of this crisis, it'll be interesting to see whose forest is in better condition.

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