A Different Kind of Recession

Axel Leijonhufvud has a very interesting article in VoxEu. The key point is that this is not a normal recession. It is one caused by the private sector trying to de-leverage. Without fixing that hole the fiscal stimulus will not work:

Fiscal stimulus will not have much effect as long as the financial system is deleveraging. Even if that problem were to be more or less solved, the government deficit would have to offset both the decline in industry investment and the rise in household saving – a gap that is rising as the recession deepens. Here, too, the public is sceptical and prone to conclude that a program that only slows or stops the decline but fails to “jump start” the economy must have been a waste of tax payers’ money. The most effective composition of such a program is also a problem.

Solutions are not simple, but the most important lesson is that if we do not understand the causes of the recession -- if we have no model for why we have unemployment now -- we cannot suggest good policies to remedy it.