Because the "cure" threatens to kill the patient. The current recession is deflationary - something we have not seen in the US since the Great Depression. Whereas monetary policy can rather easily counteract a typical recession - and be used to bring a recession on as in 1982 to "cure" the economy of persistent inflation - in a deflationary environment monetary policy has little or no traction. And today, without fiscal stimulus, we could realistically find ourselves in a deflationary spiral. Businesses and assets that are otherwise sound can get pushed down in a vicious circle of deleveraging and shrinking demand resulting from lower prices and lower wages.
This has already begun. We've effectively seen a run on the shadow banking system of investment banks, prime brokers, hedge funds, etc., as initial losses in subprime have forced firesales of other assets to meet margin calls. To be sure, the credit bubble extended far beyond subprime, and the deteriorating economic fundamentals support continuing write-downs and losses on Alt-As, option ARMs, prime mortgages, auto loans, credit card debt, student loans, etc. But the credit market's subsequent freezing has put everyone at risk, so that the recession could potentially far overshoot the "disease" of over-indebtedness and overconsumption. Absent the government stepping in and trying to make use of the wasted capacity in the economy, making up for lost private and business investment, this process could spiral on well beyond what the economic fundamentals justify, and past anyone's ability to predict as well.
Yes, this recession is the result of previous bad choices, but that doesn't mean we shouldn't try to ameliorate the worst consequences and prevent a negative feedback loop. Telling people that this is the "cure" without trying to end the cycle of loss smacks of neo-Hooverism.
No, it isn't deflationary. We had bubbles in housing, oil, food, and other commodities. Anyone remember the news articles saying "food prices are rising to levels not seen since 1998, gas prices too, the end is nigh?"
Those bubbles have burst, and prices are returning to their normal level. Over the short term, that looks like deflation (just as the bubble looked like inflation), but it's really very different from actual Japan-style deflation.
By the way, "shadow banking system" is just a scary term invented by Paul Krugman to describe non-S&L investors.
How is it actually very different from Japan-style deflation? The problem is that as the credit bubble has popped, prices across the board are falling, and consumers are so scared that even relatively well-off people are cutting back on consumption.
And once deflationary expectations set in, it's very difficult to rid the economy of them. For example, if you expect housing prices to fall even more, it makes sense to wait a few months for them to do so. If enough people act this way, deflationary expectations become self-justifying, and prices could keep falling even beyond the fundamentals. And while individuals benefit from their dollars having increasing buying power, this is more than offset by the fact that in the face of falling demand, companies will have to slash payrolls, either through benefit reduction or layoffs. This is in turn lowers demand, deteriorating the business environment even more. And this is to say nothing of the fact that people's debts become larger in real terms during deflation, likely causing more defaults of all sorts.
The shadow banking system refers to financial institutions that act like banks - ie borrow short, and lend long, oftentimes in illiquid assets - but don't have the protections that banks do, most importantly depositor insurance. Consequently, institutions like investment banks or hedge funds can still experience the equivalent of bank runs. Bear Stearns was a perfect example of this.
No, it isn't deflationary. We had bubbles in housing, oil, food, and other commodities. Anyone remember the news articles saying "food prices are rising to levels not seen since 1998, gas prices too, the end is nigh?"
Those bubbles have burst, and prices are returning to their normal level. Over the short term, that looks like deflation (just as the bubble looked like inflation), but it's really very different from actual Japan-style deflation.
By the way, "shadow banking system" is just a scary term invented by Paul Krugman to describe non-S&L investors.
This has already begun. We've effectively seen a run on the shadow banking system of investment banks, prime brokers, hedge funds, etc., as initial losses in subprime have forced firesales of other assets to meet margin calls. To be sure, the credit bubble extended far beyond subprime, and the deteriorating economic fundamentals support continuing write-downs and losses on Alt-As, option ARMs, prime mortgages, auto loans, credit card debt, student loans, etc. But the credit market's subsequent freezing has put everyone at risk, so that the recession could potentially far overshoot the "disease" of over-indebtedness and overconsumption. Absent the government stepping in and trying to make use of the wasted capacity in the economy, making up for lost private and business investment, this process could spiral on well beyond what the economic fundamentals justify, and past anyone's ability to predict as well.
Yes, this recession is the result of previous bad choices, but that doesn't mean we shouldn't try to ameliorate the worst consequences and prevent a negative feedback loop. Telling people that this is the "cure" without trying to end the cycle of loss smacks of neo-Hooverism.