10-18-2012, 01:32 AM
Well, Art, thanks, but I find it really staggering that the nature of the recession has hardly entered mainstream discussion.
When the financial system was nearly wiped out and bank balance sheets greatly affected (largely by their own doing) and a whopping $9T was wiped off the balance sheet of housing due to a 40% drop in home values, you clearly have a different kind of recession than a garden variety business cycle in which the Fed takes away the punch as the economy is overheating (like in 1979-80) ramping up interest rates to squeeze out inflation (to nearly 20%, as in the early 80s).
When rates are lowered, things go back to normal pretty quickly.
Not so this time. Banks and households have to digest the damage to their balance sheets through a process of deleveraging by borrowing/lending less (despite record low interest rates, monetary policy is near impotent under these circumstances).
As we know from history, deleveraging of the private sector risks spinning the economy in a debt-deflationary spiral (with little immediate remedy as monetary policy is impotent) and is a protracted process, hence the tepid recovery.
This isn't just obvious from theory (largely based on Irving Fisher in the 1930s and Richard Koo who studied Japan, where something similar happened), it's also clear from history, as Reinhart and Rogoff have explained.
When the financial system was nearly wiped out and bank balance sheets greatly affected (largely by their own doing) and a whopping $9T was wiped off the balance sheet of housing due to a 40% drop in home values, you clearly have a different kind of recession than a garden variety business cycle in which the Fed takes away the punch as the economy is overheating (like in 1979-80) ramping up interest rates to squeeze out inflation (to nearly 20%, as in the early 80s).
When rates are lowered, things go back to normal pretty quickly.
Not so this time. Banks and households have to digest the damage to their balance sheets through a process of deleveraging by borrowing/lending less (despite record low interest rates, monetary policy is near impotent under these circumstances).
As we know from history, deleveraging of the private sector risks spinning the economy in a debt-deflationary spiral (with little immediate remedy as monetary policy is impotent) and is a protracted process, hence the tepid recovery.
This isn't just obvious from theory (largely based on Irving Fisher in the 1930s and Richard Koo who studied Japan, where something similar happened), it's also clear from history, as Reinhart and Rogoff have explained.