An unnecessary, inevitable slump
Alongside Gauti Eggertsson of the New York Fed, Paul Krugman has been spending some time on a longer paper looking at debt, deleveraging, and liquidity traps. Building the model for it, he says, has helped him see the crisis more clearly. And what he's seen has depressed him:
If our view of the current crisis as largely a deleveraging shock is correct, and if our basic outline of how things work in the aftermath is also correct — both of which I believe — then the gods really hate us. For the slump that follows a deleveraging shock is simultaneously gratuitous and almost impossible to avoid.
What do I mean by that? The model, and more broadly overall logic, suggests that there is good no reason why the economy has to suffer a large loss of output and employment after a Minsky moment. The capacity is there, and nothing about the fact that some people have too much debt makes it impossible to use that capacity to produce goods and services for other people.
But the policies that can prevent that gratuitous slump — a commitment to higher inflation over the medium term, and/or deficit spending — run right up against ingrained prejudices. The foundations for the shock were laid by a long period of relative stability, especially low inflation; it’s very hard for policy makers to accept that what was good in 2000 or even 2007 is no longer at all good now that Minsky has struck. And everyone has just seen the punishment for too much debt; asking others to run up debt to help fix the problem, even though it’s right, is unavoidably a tough sell.
| November 19, 2010; 11:23 AM ET
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