But yes, we need to get away from the idea that encouraging increased household sector indebtedness is a good idea. I would much rather that household sector balance sheets were expanded by government spending than by debt financed asset purchases (and the resulting volatile asset price inflation). The banks would be against that though, and that might be a problem in a political system vulnerable to corruption.

However, I’d like to suggest an additional factor: secular problems in wage growth and incomes for the vast majority of workers (and arguably relatively high unemployment and underemployment even in boom times compared to the 45-75 period) created a long-term problem of insufficient demand relative to growing supply; financial bubbles and a massive expansion of credit were used to cover for the slack, thus when the bubble burts, demand drops fast.

Now, we’ve shoveled a hell of a lot of money at banks, insurance companies, etc. but far less to actual consumers, which means demand doesn’t recover that much. Hence, relative to the cash on hand they have, capital is holding back from investment because they don’t see consumer demand out there. At the same time, a labor market regime centered on labor shedding/increasing casualization/speed up and stretch out prevents the private labor market from generating enough jobs to really decrease unemployment and generate new consumers, which creates a self-fulfilling prophecy of insufficient demand.

I think the causality, if anything, runs the other way. It’s an interactive process, of course, but underestimating the influence of credit in intensifying, prolonging and distorting business cycles may be the main reason why mainstream economics gets so tangled up over our current unhappy state of affairs.

Certain consequences tend to follow such credit driven booms:

- Since a decent (and increasing) chunk of demand during the boom years was funded by borrowing, when it finally ends ongoing, sustainable demand is necessarily reduced. Particularly compared to the apparent boomtime trend.

- The productive structure created to meet that (partially) unsustainable demand isn’t all that well aligned to the new, more austere state of affairs. Even if everyone does everything right, sorting out those misalignments and excesses takes time and money, and both employment demand and new investments unavoidably suffer.

Until the sector balance sheets that got badly out of whack during the boom are sorted out, renewed organic growth is essentially impossible. Indeed, in the absence of official efforts to sustain liquidity, bolster demand and generally force-feed economic activity, I’m pretty sure most countries would have experienced full-blown depressions in recent years.

Unfortunately, many (perhaps most) of these official efforts either ignore the need for these adjustments or actively fight them. That in turn slows and confuses the private sector’s attempts to sort itself out. Certainly, once enough economic activity has been “borrowed” from the future during an extended credit-based boom, there’s no easy answer.

In any case, it doesn’t seem to me either the source (or the continued intractability) of these macro problems is all that mysterious.

If you treat the financial sector meltdown as a technology shock, RBC amounts to little more than the observation that opium makes you sleepy because of its dormitive quality.

I’m not an economist, but can’t you treat a big increase in crime as a technology shock … including the financial crime that was part of the financial crisis?

So, for example, if we had had a really massive increase in bank robberies, this could be regarded a exogenous shock with real economic impact. In the case at hand, the problem is not guys with masks and guns holding up the banks, but insider fraud: but can’t it be a technology shock in the same way?

You’ll have to define right wing for me. Authoritarian fascists? Yup, you’re right. Might be a little extreme as a description of those who argue, for example, that detailed planning of the economy isn’t all that good an idea. A statement that 30 years ago would have been described as “right wing” and today has JQ signing up to it.

It is important to know your enemy Tim and be honest to yourself about what he/she really stands for. The choice for right wing economists is evil or stupid. Which is it?

It depends on what finanial assets are being swapped. It’s hard to argue that swapping safe and liquid assets (Treasuries) for reserves would make a substantial difference on bank balance sheets, but purchase of more risky assets could. In QE1, the Fed purchased a lot of low-quality high-risk assets (mostly MBS) from banks, which did substantially reduce risk off of the balance sheets. At the time, the primary impact was to keep banks from failing, rather than giving them more space to make loans. The current rounds of MBS purchases are hoped to help make more space for loans.

But even people like Bernanke have been saying that there is a limit to what monetary stimulus can achieve. The first part of the factors JWM cites at 60 comes into play – the banks calculation of the potential risk and returns for making loans. If the bank feels that demand is too low and thus the loan too risky, they won’t fund it. For that matter, if businesses feel that customer demand is insufficient to support the loan, they won’t apply in the first place. It is not clear that the reason for the slow recovery is still due to lack of credit.

Fisher’s work on debt and deflation is still valid.

Sure JW. That’s true in principle. But once a bank has abundant liquidity and it is still not lending, I see no reason to think that the central bank can impact things by swapping in even more liquidity for other financial assets.

I think it interesting (maybe even indicative) that the worst effected countries have been countries with substantial trade deficits – which rather contradicts some expressed forecasts of bigger effects on exporting countries. Which makes me think that household balance sheet stories (deficits being flows of wealth out of a country) are more convincing.

Not necessarily – not if the USD is a de facto global currency. This comes back somewhat to the (for me at least) tricky question of “what exactly is money”!

You seem to be intertwining a number of concepts and focusing on micro-economics rather than macro. Allow me to take a few of your points and try to refocus them a bit – I’m not entirely disagreeing, just tying to put your points back into a macro context.

Grant that a key component of the 2008 financial crisis was over-levered financial institutions, the question becomes why was that so.

The answer in part, was easy credit facilitated on the macro by the Fed’s easy money/low interest rate choices and on the micro by the creation of CDOs and other hybrid vehicles which leveraged exposure to underlying collateral (i.e a relatively small group of mortgages influenced a large group of securities via indexation). In economic terms these vehicles reduced structural barriers to capital formation, but had a cost in increasing system volatility.

The banks themselves don’t escape blame – their lending standards were crap regardless of how they were facilitated – but these are also micro concerns. The macro is that both supply and demand collapsed concurrently when lending problems materialized…lets just agree there were problems since listing out the dozen or so structural problems with lending on a low collateral basis on inflated asset values is somewhat intuitive.

Staying with the macro – The creation of unemployment was the contraction of GDP which was influenced by credit contraction as well as business cyclicality which included lower construction due to credit contraction, Europe, less-easy money (rates were rising by 2007), political uncertainty….lets say many of the usual business cycle culprits.

No, it wasn’t unions in the case of AIG or Lehman, but union contracts were a factor in airlines, autos and auto parts companies that had to manage the same GDP contraction. The fact that in the case of GM they were also a major participant in real-estate financing through GMAC (and its subs) accelerated their failure…

The question that this board is trying to examine – is not why the unemployment was created, but why it hasn’t eased or what would make it ease. Some examination of causality is helpful in identifying that answer (as I posted at 31), but that is ultimately micro-economics – not macro.

You may (as many have) reach the conclusion that macro economics isn’t helpful in answering this question and that isn’t an unrealistic view – but conspiracy theories about AIG, Goldman Sachs, Paulson and the like while surely interesting, have no relevance to what form of after-the-fact economic policy – spending, monetary policy, easing regulation etc. would be most effective in bringing about the desired outcome of lower unemployment.

In macro economic terms – your concerns about moral and financial corruption (not necessarily off base) are classified as structural impediments that would either be addressed by regulation or would simply demand a greater monetary or fiscal response to overcome depending on bent.

The nature of your questions and comments suggest that you don’t really have the heartbeat of a macro-economist but would fall into the camp (as mentioned in the OP) that thinks micro has more of the answers and macro mostly has questions.

I’m not just saying that because you disagree with me.

And you are still not replying to my simple point that we have evidence of the shape of the Earth.