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Aughts were a lost decade for U.S. economy, workers

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Consumers weren't the only ones. The same turn to debt played out in commercial real estate and at financial firms. It resulted in a corporate buyout boom that often produced little of lasting value. It is a truism of finance that for businesses, relying heavily on borrowed money makes the good times better but the bad times far worse. The same thing, as it turns out, could be said of the nation as a whole.

The first decade of the new century was an experiment in what happens when an economy comes to rely heavily on borrowed money.

"A big part of what happened this decade was that people engaged in excessively risky behavior without realizing the risks associated," said Karen Dynan, co-director of economic studies at the Brookings Institution. "It's true not just among consumers but among regulators, financial institutions, lenders, everyone."

The experiment has ended badly. While the stock market bubble that popped in 2000 caused only a mild recession, the housing and credit bubble has had a much greater punch -- driving the unemployment rate to a high, so far, of 10.2 percent, compared with a peak of 6.3 percent following the last such downturn.

The impact of the real estate crash has been broad. Among middle-income families, 69 percent owned a home in 2007, more than four times the proportion owning stocks. And as the housing meltdown cascaded through credit markets, the banking system was buffeted, rocking the whole financial system on which the world's economy rests.

With luck, lessons

Economists and policymakers will be chewing on the lessons of the Aughts for many years to come; the events of the past two years alone are enough to launch a thousand economics dissertations. If past periods of economic trauma are a guide, this research will yield a deeper understanding of how to manage the economy.

The Great Depression of the 1930s led to new insights about the impact a financial collapse can have. The primary lesson -- espoused by Ben S. Bernanke as an academic before acting on it as Fed chairman -- was "Don't let the financial system collapse."

The Great Inflation of the 1970s brought a rethinking of what drives inflation, such that economists now put a premium on maintaining the credibility of central banks and keeping inflation expectations in check.

The lessons of the Bubble Decade are still being formed. At the Federal Reserve, the major lesson that top officials have taken is that bank regulation shouldn't occur in a vacuum; rather than monitor how individual institutions are doing, bank supervisors should try to understand the risks and frailties that the banking system creates for the economy as a whole -- and manage those risks.

Fed leaders have been more skeptical of the idea that they should routinely raise interest rates to try to pop bubbles. "I can't rule out circumstances in which additional monetary policy actions specifically targeted at perceived asset price or credit imbalances and vulnerabilities" would be advisable, Fed Vice Chairman Donald L. Kohn said in a recent speech.

"But given the bluntness of monetary policy as a tool for addressing developments that could lead to financial instability, the side effects of using policy for this purpose, and other difficulties, such circumstances are likely to be very rare."

And the question of how Washington can prevent a recurrence is an overarching theme in the Obama administration's efforts to overhaul the financial system and support growth through investments in clean energy and other areas. "One of our challenges now," President Obama said in November, "is how do we get what I call a post-bubble growth model, one that is sustainable."

The financial crisis is, for all practical purposes, over, and forecasters are now generally expecting the job market to turn around early in 2010 and begin creating jobs. The task ahead for the next generation of economists is to figure out how, in a decade that began with such economic promise, things went so wrong.

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