The Accidental Recession

Brad DeLong on what makes this recession different:

As soon as the Fed had achieved its inflation-fighting goal, however, it would end the liquidity squeeze. Asset prices and incomes would return to normal. And all the lines of business that had been profitable before the downturn would become profitable once again. From an entrepreneurial standpoint, therefore, recovery was a straightforward matter: simply pick up where you left off and do what you used to do.

After the most recent US downturn, however (and to a lesser extent after its two predecessors), things have been different. The downturn was not caused by a liquidity squeeze, so the Fed cannot wave its wand and return asset prices to their pre-recession configuration. And that means that the entrepreneurial problems of are much more complex, for recovery is not a matter of reviving what used to be profitable to produce, but rather of figuring out what will be profitable to produce in the future.

I wonder if this can't be reformulated into more of an expectations framework. During the recession associated with the Volcker Disinflation, everyone understood the recession to have been induced by deliberate Federal Reserve policy. Then a time comes when the Open Market Committee decides that enough disinflating has happened and it wants to start boosting growth. So the Fed waves its wand, and expectations coordinate very rapidly around expectations of growth and those expectations are largely self-fulfilling. But when the economy stumbles into a recession by accident, things look different. And they especially look different because policymakers most certainly don't immediately rush out in front of the cameras to say "holy shit, we fucked this up, sorry guys, we're going to fix it." Instead they emphasize an exculpatory narrative. They don't say "this happened but we didn't intend for it to happen," they say "this happened for reasons beyond our control." That's good for helping Ben Bernanke get named person of the year but bad for the Fed's ability to re-coordinate expectations around growth.

Now consider the situation of the 1930s. The economy falls into Depression in 1929 and things get worse and worse. But then FDR takes office in 1933, loudly proclaiming that the policies are in fact the fault of the incumbent policymakers. But now "[t]he money changers have fled from their high seats in the temple of our civilization," the bums have been kicked out, happy days are here again, "the only thing we have to fear is fear itself," and dramatic new monetary policy initiatives are being undertaken to restore growth. So suddenly the magic wand works and output begins moving back toward its potential.