Could We Have Had a Severe Recession Without the 2008 Financial Crisis?

Over at Grasping Reality: Monday DeLong Smackdown: Scott Sumner: Could We Have Had a Severe Recession Without the 2008 Financial Crisis?: “I have trouble with DeLong’s implicit assumption is that the financial crisis caused the Great Recession….

The years leading up to 1990 saw Australian-level NGDP growth, if not more. So even if lending standards tightened sharply in the wake of the 1989-90 crisis, there was no possibility of hitting the zero bound…. With no zero bound in prospect, there’d be no reason for markets to expect an NGDP collapse…. Even if we had managed the 2007-08 subprime crisis very well from a regulatory/resolution perspective, there is no question that banks would have tightened lending standards sharply. That effectively reduces the demand for credit…. It’s quite plausible that the Wicksellian equilibrium natural rate would have fallen to zero in late 2008, even with a better resolution of the banks….

One area where I slightly disagree with Krugman is his focus on inflation. A 5% NGDPLT target path would have been enough, we didn’t need 4% trend inflation. Nor do we need fiscal stimulus…. All stabilization policies eventually fail…. The trick is to have a modest failure like Clinton or Obama, not a serious failure like FDR or Nixon. NGDPLT would have given us just that in 2008-09.

Graph Private Residential Fixed Investment FRED St Louis Fed

As I have said repeatedly: I simply do not buy this. From the fourth quarter of 2005 through the fourth quarter of 2007 lending standards tightened enormously, and investment is residential construction collapsed. By the end of 2007 residential investment had fallen 2.5%-points from its peak-of-the-boom level. But the heightening of lending standards and the unwillingness of people to make further NINJA (no income, no job or assets) loans had not sent the economy into any sort of a recession. It was the spiking of risk premia in 2008 that sent us to Wicksellian natural-rate-of-interest-below-the-ZLB territory. And there is no reason to think that we would have been in such a situation but for the financial crisis–and every reason to think that the whole mishegas would have been avoided had congress simply put the too-big-to-fail banks into conservatorship in January 2008…

April 21, 2014


Brad DeLong
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