In the Second Great Contraction, Kenneth Rogoff, an economist from Harvard University, writes that our national and global economies are greatly overleveraged, so we can not expect a typical business cycle recovery -- because we are not in a typical business cycle. But, unlike many others who believe this is not a typical business cycle, such as Reich, Krugman, and Stiglitz, Rogoff doesn't believe a fiscal stimulus alone will be sufficient, as he sees the problems as primarily one of too much debt. Until we eliminate the enormous over-hang, and imbalance of debt, we will not be able to recover.
Either, we have to find ways to write-off bad debts, or inflate our way out of this current crisis, with a sustained inflation rate of 6% to 7%, which is essentially, a broad based, inescapable transfer of wealth from savers to consumers.
CAMBRIDGE – Why is everyone still referring to the recent financial crisis as the “Great Recession”? The term, after all, is predicated on a dangerous misdiagnosis of the problems that confront the United States and other countries, 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. ... Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.
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.
Rogoff proposed that we call our situation the "Second Great Contraction." The Great Depression was the first. After a typical business cycle recession, the economy typically, catches up to past levels and returns to growth, in a year of so. But, in a Great Contraction, output, employment, debt, housing prices, and equity can take 4 or more years to recover. From studies I remember of the Great Depression, some of these variables too over a decade to fifteen years to reach original levels.
Rogoff counters Paul Krugman's analysis that the fiscal stimulus failed because it was not large enough. Rogoff's view is that it failed because the problem was too much debt.
So how do we get out of this imbalance of debt? We will need to use a combination of creative write-offs, and sustained inflation.
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.
In my December 2008 column, I 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. ...
Rogoff argues that by correctly diagnosing our current troubles as the Second Great Contraction, instead of a Great Recession, we will take our first steps towards recognizing we need more than the conventional approaches to recover.
I've advocated long-term inflation to rebalance the out-of-whack debt, and distribution of wealth. The trick is to stay below a level that might cause hyper-inflation, or other countries to no longer buy our debt.
Rogoff does not address the obvious question of why anyone would continue to buy our debt, if we announce this is our strategy.
The answer might be that they have no place else to go, as many other economies either have the same troubles, or are not as safe for investors.
But, it will be a delicate balance that will require a lot more thought than Rogoff provides so far.
I do believe he has a piece of the puzzle, that we must add to the Reich, Krugman Keynesian stimulus approach. This is worth your time reading in full.
6:47 PM PT: This is the first diary in Keynesian Kossacks. Rogoff is an odd choice I admit, I should have started with Reich, Krugman, or Stiglitz, but this article popped out, and raises intelligent questions at least.
Hey, anyone who wants to join and help manage this group is welcome to.
I'm already way overextended so will need help watching the diary ques, and invite and accept folks.
I am hoping we can amp up the need for jobs and economic stimulus for infrastructure repair, and investment, and investment in sustainable energy production, to counter this terrible debt-ceiling compromise that is going to take over $2 trillion out of our economy at the wrong time.
Maybe we should discuss having a US industrial and economic strategy like many other countries do?