Two theories of recession

Because, as Warsh points out, Obama’s stimulus is being sold as a hangover cure, perhaps contrary to the instincts of his advisory team. The Obama stimulus is pitched to revive demand following a sudden crash that itself followed thirty years of flat-out economic expansion. Kevin Rudd is selling his stimulus on the same platform. The simple moral tale behind the hangover explanation makes it more politically saleable in both countries and, no doubt, it is in tune with the Prime Ministers’ own disposition to employ moral explanations.

Unlike Rudd, Obama has little alternative to a hangover cure. In contrast to the Australian case, there is almost no gas left in the US monetary policy tanks to undermine an excess demand for cash (by dropping interest rates).

Most of Obama’s neo-Keynsian economic technicians would, however, presumably be inclined to argue that a hangover cure will be at best weak and temporary because it addresses the symptoms not the disease.

Sooner or later the United States government must address the underlying reason for the excess demand for cash and its counterpart, the freezing of credit. The underlying reasons are pretty evident: frightening doubts about the solvency of the banks. This problem demands the isolation of bad and un-valued debts and the re-capitalization of the banks, including by partial nationalization if necessary.

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