Meltdown will leave vastly changed economy

John W. Schoen Senior producer • Profile • E-mail

With the economy showing early signs of stabilizing, it's time to start wondering: What is the 'new normal' economy going to look like?

I have a question that I'm sure a lot of people wonder about. What is a "back-to-normal" economy? Is it to go back to fiscal irresponsibility and reckless spending?
Jason P., Kandahar, Afghanistan

A lot people are wondering what the “new” normal will look like once the worst of the financial crisis and recession have passed. Even the most optimistic scenarios see only very gradual improvement in economic growth, with unemployment remaining high for the next several years. The only honest answer is that no one really knows.

Even beyond the specific forecasts for growth, it’s pretty clear that the economic collapse of the last year will bring profound changes in the global economy and financial system. We’re still in early innings, though, so much depends on how we respond from this point forward.

If you see the glass as half full, the "new normal" could bring long-overdue positive changes. When lenders make bad loans, they lose money. This time they lost big piles of it, which means they’re going to be a lot more careful in the future. That's a good thing, unless they're too careful and make it too hard to get a loan.

Other changes are long overdue. For government, cutting taxes without cutting spending turned out to be a multitrillion-dollar mistake. Consumers who thought that a credit card was a savings account and a home was a piggy bank have learned the hard way that neither of those things are true.

Those lessons are pretty hard to unlearn. (Though you could argue that, three generations after the Great Depression, that’s exactly what we did.)

The "new normal" could also bring some unpleasant changes. To stop the downward spiral, the government has flooded the economy and financial system with more than $1 trillion in loans from the Federal Reserve and roughly the same in new spending from Congress. That may put the fire out, but there’s going to be a major mess to clean up.

Adding $1 trillion to the money supply in a matter of months, for example, creates a major risk of inflation down the road. Successfully sopping up that much money from the economy without tipping it back into recession is a feat the Fed has never tried before.

If Congress and the White House try to balance the budget too quickly with spending cuts, tax increases or both, that could also send the economy back into a downward slide. But over the longer term, if they can't figure out how to whittle away at the massive pile of government debt, investors could lose faith in the dollar. That would drive up interest rates and put a major lid on economic growth. 

In any case, the events of the past few years will have a lasting psychological impact. No matter how well they’re still paying themselves, most financial industry professionals have been humbled by the disastrous effects of the financial alchemy they unleashed on the rest of us. If nothing else, it’s in their own self-interest to avoid another rogue wave of risk-taking.

The financial meltdown has also created a broad consensus that the system of regulating the financial markets is badly broken. The debate over how to fix that system will have a major impact on what the “new normal” looks like.

Finally, the impact on consumers, investors, savers, workers and homeowners can’t be understated. For the past 30 years, we have lived with the mistaken belief that we can buy stocks and houses without any real risk of losing money over the long run. Lesson learned.

It’s also becoming clear that we can either expect less services and benefits from our government or pay more in taxes. Borrowing the difference isn’t a sustainable plan.

MORE FROM ANSWER DESK

Answer Desk Section Front

Who needs overpaid bankers? Who gets extended jobless benefits Easing job losses point to wobbly recovery Long-term jobless face frayed safety net GDP growth overstates case Recession over? Readers don't believe it Breaking down the cost of health care Commercial real estate bust looms 'Official' job numbers don't tell the whole story Getting mortgage help Answer Desk Section Front   Add Answer Desk headlines to your news reader: