Note: This is an argument in favor of not avoiding recession but of avoiding depression.
Kindleberger’s commentary in his review of the Great Depression is interesting. In the piece I quoted from “The Slide to the Abyss”, I noted the following from Kindleberger:
On one view of the depression, the continued revival of international long-term lending was vital. Those who blamed the depression on the preceding boom or inflation were typically not moved to make lending easy. They thought it necessary to put the system through the wringer, to liquidate the mistakes of the past and eliminate dead wood. Their ranks included such economists as Robbins and Hayek and, in the US government, the secretary of the Treasury, Andrew Mellon. Opposing them were many differing schools of thought, ranging from monetarists, market stabilizers, and interventionists to planners, all of whom thought it useful, however, to bolster rather than liquidate markets. The issue is fundamental.
The Austrian in me says avoiding recessions eventually leads to crisis through the build-up of macro disequilibria. Back in 2008, I did a few charts which showed how distorted the US economy had become. New home sales were way over the top as was the real increase in house prices. US debt, was through the rough along with the current account deficit. And the savings rate absolutely plummeted while household debt climbed. There were some serious macro disequilibria. My conclusion back in 2008 was:
As the upturn lengthens, human beings become acclimated to the good times. As a result, credit becomes easier, leading to unexpected bad debts and an economic downturn.
Therefore, recessions are the painful, but necessary, way of reminding both borrowers and lenders what types of lending arrangements are actually judicious. I would argue that recessions are endemic to the business cycle and should not be avoided.
–Should we try to avoid recessions?, Jul 2008
Avoiding recession has been an important goal of economic policy in the Anglo-Saxon world. That view leads to an asymmetry whereby stimulus is applied in much greater amounts to end recession than is taken away to stop overheating. This asymmetry, often called the Greenspan Put in the US when Alan Greenspan was Federal Reserve Chairman, is directly responsible for the build up of private sector debt, financial leverage, and current account deficits.
Avoiding recession and avoiding depression are two different things. In a panic, the economy is in disequilibrium. Market crashes, property crashes, bankruptcies, and bank runs can lead to some serious knock-on effects and dead-weight economic loss, especially when the downturn is global. The Keynesian in me says debt deflation and depression are the result of this disequilibrium. Obviously you want to prevent moral hazard by letting truly bankrupt enterprises fail. To me, it’s all about the credit writedowns. My view is that until these failures occur and until creditors write down unpayable debts, debtors can only be sustained through gambling on greater income from more debt as an out. You are just papering over the situation and storing up more problems for later. The point of Keynes is to have government work counter cyclically as it should since the sector balances mirror each other (non-government surplus equals government deficit). You only exaggerate business cycles through pro-cyclicality otherwise. As Felix Zulauf recently pointed out, cutting government into the teeth of recession makes a debt deflation and crisis more likely.
Moreover, I believe that, in the absence of stimulus, the present global crisis would be much more severe. In fact, it could threaten systemic collapse and a Great Depression — if allowed to continue without some measure of countervailing monetary and fiscal stimulus. Not everyone agrees with this view. Some believe that the economy is self-equilibrating, meaning that the ship will eventually right itself once you “purge the rottenness out of the system”, as Andrew Mellon is reputed to have said.
I wrote a lengthy post dedicated to this theme. My prediction was that a “collective debt reduction across a wide swathe of countries cannot occur indefinitely under smooth glide-path scenarios”. I said trying to cut government and private sector debt at the same time would be the origins of the next crisis.
In the end, however, avoiding recession leads to bubbles and bubbles lead to systemic risk and depression. It is far better to allow the recession to occur, write unpayable debts down, and mitigate the effects through automatic stabilsers than to risk a depression in which massive stimulus is seen as necessary.
That’s how I’d like to present my argument in today’s economic climate.
Source: “The Slide to the Abyss”, The World In Depression – Charles P. Kindleberger