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Tuesday, August 02, 2011

Rogoff: The Second Great Contraction

I think the term "balance sheet recession" -- and the associated policies many of us have been pushing (unsuccesfully) -- takes care of this concern:

The Second Great Contraction, by Kenneth Rogoff, Commentary, Project Syndicate: Why is everyone still referring to the recent financial crisis as the “Great Recession”? The term, after all, is predicated on a dangerous misdiagnosis ... leading to bad forecasts and bad policy.
The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war US recessions have gotten it so wrong. Moreover, too many policymakers have relied on the belief that ... this is just a deep recession that can be subdued by a generous helping of conventional policy tools...
But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.
A more accurate, if less reassuring, term for the ongoing crisis is the “Second Great Contraction.” Carmen Reinhart and I proposed this moniker in our 2009 book... The first “Great Contraction” of course, was the Great Depression... The contraction applies not only to output and employment, as in a normal recession, but to debt and credit, and the deleveraging that typically takes many years to complete.
Why argue about semantics? Well, imagine you have pneumonia, but you think it is only a bad cold. You could easily fail to take the right medicine, and you would certainly expect your life to return to normal much faster than is realistic. ...
The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.
Acknowledging that we have been using the wrong framework is the first step toward finding a solution. History suggests that recessions are often renamed when the smoke clears. Perhaps today the smoke will clear a bit faster if we dump the “Great Recession” label immediately and replace it with something more apt, like “Great Contraction.” It is too late to undo the bad forecasts and mistaken policies that have marked the aftermath of the financial crisis, but it is not too late to do better.

I wrote this last December:

Recessions can occur for a variety of reasons. For example, oil price shocks, stock market crashes, housing bubbles, monetary shocks, and productivity shocks can all lead to economic downturns. However, curiously, while the effects of a recession differ depending upon the cause, the response of policy – fiscal policy in particular – tends to be the same. This is undesirable, since a policy tailored to the specific type of recession would result in a speedier recovery. Monetary policy is better on this score, particularly nontraditional policy, but even this could be improved along these lines.

And I wasn't the only one making this point.

    Posted by on Tuesday, August 2, 2011 at 11:07 AM in Economics | Permalink  Comments (47)


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