On an ordinary day, Henry Aaron, senior fellow in economic studies at the Brookings Institution in Washington, comes across as the quintessential policy wonk: knowledgeable, thoughtful, measured, perhaps even a tad boring. With his rumpled suits, snowy hair, and rosy jowls, the genial septuagenarian brings to mind one's favorite uncle--assuming that uncle had spent the past 40 years exploring tax policy, health care financing, and the intricacies of sprawling entitlement programs.

Financial markets have stabilized--people believe that the U.S. and West European governments will not allow big financial institutions to fail. We have effectively nationalized any banking system losses, but we’ll let bank executives enjoy the full benefits of the upside. How much shareholders participate remains to be seen; there will be no effective reining in of insider compensation (my version; Joe Nocera’s view). Small and medium-sized banks, however, will continue to fail as problems in commercial real estate continue to mount. The economic recovery, in the short-term, may be surprisingly strong in terms of headline numbers; this is a standard feature of emerging markets after a crisis (e.g., Russia from 1998 or Argentina after 2002).  Official short-term forecasts are probably now too low, as the IMF and other organizations make the case for continued fiscal stimulus and very loose monetary policy.

However, a two-track economy appears to be developing: One part will do well (e.g., around big banks on Wall Street), and another part will struggle (many consumers and firms around the world want to reduce their debt; the same thing happened in Japan’s “lost decade”). During the 1990s, Japan had some years with good growth, but overall the decade was a disappointing deceleration of growth; the same could be true now at the global level.

Longer term U.S. growth prospects remain particularly uncertain--has consumer behavior really changed?; if finance doesn’t drive growth, what will?; is the budget deficit under control or not (note: most of the guarantees extended to banks and other financial institutions are not scored in the budget)? The implication, presumably, is higher taxes on the productive nonfinancial part of the economy--to pay for the implicit subsidies and ongoing rents of the financial sector. While many entrepreneurs understand and resent this math, they are strikingly unwilling to do anything about--or even speak out on--reining in the power of the biggest banks. Even the smaller banks--who have really been hammered by the actions of larger banks--are only just now figuring this out and beginning to express resentment; sadly, this is too late to make much difference.