US Economy: Great Depression, Great Recession, Great Contraction – Which one?

Kenneth Rogoff – Professor of Economics at Harvard and former Chief Economist at the IMF – wrote an interesting piece suggesting that policy makers have got it wrong in describing the recent financial crisis as the ‘The Great Recession’. At the bottom of the post there is a very good interview with Rogoff criticising the present policy decisions in the US. Some good references to behavioural economics.

Great recession suggests that the economy is following the contours of typical recession but that it is more severe. Subsequently forecasters who have tried to make resemblance to post-war US recessions are “barking up the wrong tree” and are of the belief that conventional tools like expansionary fiscal policy, quantitative easing and bailouts are way to go. The real problem is that the global economy is badly leveraged and there is no quick fix without a transfer of wealth from creditors to debtors. Rogoff suggests that the “Second Great Contraction’ is a more realistic description of the current crisis in the global economy. The “First Great Contraction” was the Great Depression of 1929 but 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 typical recession the economy returns to pre-recession growth within a year and in most cases catches up to its rising long-run trend. The repercussions of the financial crisis typically can take 4 years just to reach the same per capita income level that it had attained at its pre-crisis peak.

Rogoff argues that the only practical way to shorten this coming period of painful deleverging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Although inflation is unfair as it is the transfer of income from savers to debtors, 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.

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.

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