Must-Read: Mark Thoma: Krugman v. DeLong

Must-Read: The hawk-eyed Mark Thoma picks up and develops a very important point:

Mark Thoma: Krugman vs. DeLong: “Theoretical models often act as if there is only one type of demand shock…

…and the short-run depends upon a single variable, e.g. the time period when inflation expectations are wrong. But the short-run depends upon the type of recession we experience, and the variable that signals the length of the recovery will not be the same in every case. A monetary induced recession will have a much shorter short-run than a balance sheet recession induced by a financial collapse, and an recession caused by an oil price shock will recover differently from both.

Early in the Great Recession, policymakers, analysts, and most economists did not fully recognize that this recession truly was different, and hence required a different policy approach from the recessions in recent memory. Krugman, due to his work on Japan, did see this early on, but it took time for the notion of a balance sheet recession to take hold, and we never fully adopted fiscal policy to deal with this fact (e.g. sufficient help with rebuilding household balance sheets).

To me this is one of the big lessons of the Great Recession — we must figure out the type of recession we are experiencing, realize that the ‘short-run’ will depend critically on the type of shock causing the recession, and adopt our policies accordingly. If we can do that, then maybe the short-run won’t be a decade long the next time we have a balance sheet recession. And there will be a next time.

June 4, 2015

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