Kenneth Rogoff of Harvard suggests that this is not a“Great Recession” but a “Great Contraction.” “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.” He and Carmen Reinhart write about this in their 2009 book This Time is Different, a book I want to read.
“A more accurate, if less reassuring, term for the ongoing crisis is the “Second Great Contraction.” The first “Great Contraction” of course, was the Great Depression, as emphasized by Anna Schwarz and the late Milton Friedman. 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.
“In a conventional recession, the resumption of growth implies a reasonably brisk return to normalcy. The economy not only regains its lost ground, but, within a year, it typically catches up to its rising long-run trend.
“As Reinhart and I demonstrated, it typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak.
“Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.
“For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries. For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.
“Is there any alternative to years of political gyrations and indecision? ...I have argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery. Eventually, it will take place one way or another, anyway, as Europe is painfully learning.”
I do think that any analysis needs to take account of the unresolved housing and debt crisis of 2008. I don’t yet fully understand Rogoff’s theories or if higher inflation is the solution, but if we don’t seek understanding of these issues, we will join George Bush who said September 25, 2008 – “If money isn’t loosened up, this sucker could go down!”
The New York Times reported that he said this “as he watched the $700 billion bailout package fall apart before his eyes.... [The bailout discussions] dissolved into a verbal brawl in the Cabinet Room of the White House, urgent warnings from the president and pleas from a Treasury secretary who knelt before the House speaker and appealed for her support...
“In the Roosevelt Room after the session, the Treasury secretary, Henry M. Paulson Jr., literally bent down on one knee as he pleaded with Nancy Pelosi, the House Speaker, not to ‘blow it up’ by withdrawing her party’s support for the package over what Ms. Pelosi derided as a Republican betrayal.
“‘I didn’t know you were Catholic,’ Ms. Pelosi said, a wry reference to Mr. Paulson’s kneeling, according to someone who observed the exchange. She went on: ‘It’s not me blowing this up, it’s the Republicans.’
“Mr. Paulson sighed. ‘I know. I know.’”