........from Naked Capitalism........
I must confess to having read only a bit of economist Axel Leijonhufvud's writings, but what I have seen, I have liked very much.
Leijonhufvud's current post at VoxEU does a very good job of looking at the economic mess the US is in and assesses policy options. It is a remarkably straightforward piece. Most of the information cited will be familiar to many readers, but he connects them and concludes that stimulus will almost certainly be ineffective unless undertaken on a scale that would produce very serious inflation.
From VoxEU:
This recession is different. Balance sheets of consumers, firms, and banks are under strain. The private sector is bent on reducing debt and this offsets Keynesian stimulus more than standard flow calculations would suggest. Bank deleveraging is by far the most dangerous. Fiscal stimulus will not have much effect as long as the financial system is deleveraging.
This is not an ordinary recession that differs from other recent episodes simply by being somewhat more severe. It differs in kind.
Past recessions and the reallocation of employment
The end of the Cold War brought a decline in military spending and a recession which impinged most heavily on the states, like California, where the military-industrial complex was an important part of the local economy. The nationwide unemployment rate rose from 5.25% in 1989 to 7.5% in 1992. It then fell every year reaching just under 4% in 2000. The “free market” took care of the recession of the early 1990’s. Resources moved from the defence industries, trickling into other uses through innumerable channels. The federal government did not need to take a hand. Beginning in 1993, the federal deficit in fact shrank every year turning into a modest surplus in 1998. That was a very ordinary recession.
If the current situation were at all similar we would expect a recession in residential construction with unemployment among construction workers and mortgage brokers. Naturally, recent boom areas would be hard hit but we would expect resources gradually to trickle into alternative employment. Instead, we are threatened by a veritable disaster.
Balance sheet recessions
What is the difference? It resides in the state of balance sheets. The financial crisis has put much of the banking system on the edge – or beyond -- of insolvency. Large segments of the business sector are saddled with much short-term debt that is difficult or impossible to roll over in the current market. After years of near zero saving, American households are heavily indebted.
The holes that have opened up in the balance sheets of the private sector are very large and still growing. A recent estimate by Jan Hatzius and Andrew Tilton of Goldman Sachs totes up capital losses of $2.1 trillion; Nouriel Roubini thinks the total is likely to be $3 trillion. About half of these losses belong to financial institutions which means that more banks are insolvent – or nearly so – than has been publicly recognised so far.
So the private sector as a whole is bent on reducing debt. Businesses will use depreciation charges and sell off inventories to do so. Households are trying once more to save. Less investment and more saving spell declining incomes. The cash flows supporting the servicing of debts are dwindling. This is a destabilising process but one that works relatively slowly. The efforts by financial firms to deleverage are the more dangerous because they can trigger a rapid avalanche of defaults (Leijonhufvud 2009).
The Japanese example
http://www.nakedcapitalism.com/2009/02/we-are-threatened-by-veritable-disaster.html
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