Note to Self In response to EconSpark: Ben Bernanke: "How important was the financial panic as a cause of the Great Recession?"

One picture I have always found very illuminating is this one:

Real exports, real private nonresidential fixed investment, real residential fixed investment, real government purchases, all as deviations from their 2007:IV shares of real potential GDP.

From 2005 through the end of 2007 the housing bubble breaks—and real housing investment relative to potential real GDP falls by 3.3%-points of real potential GDP. Yet there is no recession. Expenditure is smoothly switched from residential investment to exports and non-residential investment. Consumption is not noticeably weak in spite of the impact of diminished housing wealth on households.

Thus my belief that if the financial crisis had been managed—if the Bagehot Rule had been followed, and if there had been authorities to lend freely at a penalty rate on collateral that was good in normal times—and if 2008 had passed without a crash, then our troubles would have been over. It was not the case that the economy in November 2008 "needed a recession" as John Cochrane liked to claim, "because people pounding nails in Nevada needed to find something else to do". The expenditure-switching had already happened. All that needed to be done was to keep demand for safe assets from exploding—and that is what lending freely at a penalty rate on collateral good in normal times is supposed to do.

And then, of course, in late 2008 things go to in a handbasket. And fiscal support is inadequate by orders of magnitude. And then after 2008 nothing is done to restart financial intermediation in the housing sector at its normal pace. And after 2010 we see fiscal shock after fiscal shock after fiscal shock...

And so here we are, 10% poorer than we thought a decade ago we would be now. And with lots of scarring on lots of lives and organizations...

#noted #econspark #macro #finance