Explaining the Great Recession

In a New York Review of Books article entitled "The Slump Goes On: Why?" Paul Krugman and Robin Wells review three books on the panic and recession. This is all very informative. But for me, the key bit is at the tail end of the review where the authors address the question of how to cope with the mess and try to fix it:

So what’s the answer? In the short run, the only way to avoid a deep slump when almost everyone in the private sector is trying to pay down debt simultaneously is for the government to move in the opposite direction—to become, in effect, the borrower of last resort, issuing debt and continuing to spend as the private sector pulls back. In the heat of a Minsky moment, budget deficits are not only good, they are necessary. Indeed, the surge in budget deficits around the world between 2007 and 2009 was arguably even more important than the financial rescue in keeping the real estate bust from triggering a full replay of the Great Depression.

This surge in budget deficits, by the way, wasn’t mainly the result of deliberate efforts to stimulate the economy. Instead, the main factors were a collapse in tax receipts as economies slumped, and secondarily a rise in automatic payments like unemployment insurance benefits. In the United States, the two-year federal deficit over 2009–2010 will be around $2.5 trillion; the Obama stimulus plan accounts for less than a quarter of the total.

So budget deficits kept us from falling into the abyss.

This is the very message that the central bankers and the right wing politicians and right wing economists refuse to hear. Instead, they are busy attending to the siren call of "inflation" and "debts too big to bear". Nutty stuff. When your house is burning down, you don't worry about the water bill. But that is exactly what these nutty people are doing. Instead of applying the well understood Keynesian solution, they are busy preventing the fire hoses from being laid and the firemen pointing the hoses at the flaming house. Instead they are squabbling about just how big a water bill can be "afforded". Nutty!