Wednesday, January 28, 2009

The Baseline Scenario

An interesting webpage, pointed out by Tyler Cowen, which seems to be advocating the view point that this economic recession is going to be a lot more protracted than most seem to suggest (IE, several years, instead of turning around in mid-2009). You can read their worldview here.

They argue that the crisis was really started in the 1980s, with the Great Moderation. Having a more predictable economy made finance a much more attractive field and credit a lot easier to obtain, leading to a massive build-up in debt. This is seen in the graph below which has been making the rounds around the econ blogopshere:
EDIT: Apparently the right half of the picture is cut off. Click on it and you'll see the whole picture

Too much of a bubble leads to a clamp-down in credit, which is where we were up till Mid-September. But after AIG was taken over (essentially wiping out the shareholders and I guess the creditors too) and Lehman was allowed to fail, a panic was sparked, which has led to people, corporations, and governments all over the world starting to limit the amount of debt they have, and increasing their savings.

Essentially, we are in one massive, global, Paradox of Thrift situation. And it may be a llllooooonnnnngggg time before debt levels reach a new equilibrium, which means it will be a long time before the global economy starts to recover. And unlike Japan, we can't export our way out of this problem, since the Martian market for financial services really hasn't taken off yet.

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