Ten Miles Square


March 11, 2013 10:56 AM How Does Jeff Sachs Explain the Great Recession?

By Ryan Cooper

First, let me recommend Mark Thoma, who takes apart Sachs’ very crude representations of Paul Krugman’s positions. I want to circle back to one particular point that leaped out at me:

One of the Obama arguments at the time was that the rush in the stimulus program was needed to avoid a Great Depression. This was and is highly doubtful (though, yes, it is widely accepted). The US economic emergency in late 2008 and early 2009 wasn’t really an aggregate demand crisis but a financial crisis. The chaotic failure of Lehman Brothers had led to an intense panic and credit squeeze. The Fed therefore needed to flood the markets with liquidity, which it rightly did, in order to unwind the panic. The Fed’s action was the real difference with 1933 (when the Fed allowed the banks to fail). It was the Fed, not the fiscal stimulus, which prevented a fall into depression.

Emphasis mine. I was under the impression that the basic consensus economic story of the 2008-9 crisis was that yes, we had a banking crisis. According to accounts like Gary Gorton’s, this differed in many details from previous versions in that it involved the repo market and a bank run driven by institutions, not individuals, but was of basically the same character of financial panics of ages past.

And financial panics cause aggregate demand crises. Banks fold up or get very shy with credit, suddenly nonfinancial institutions can’t get loans and they fold up or shrink, leading to layoffs, which means people have less money, which means less total spending, further hurting businesses, in a self-perpetuating cycle. There are other aspects of the current economic problem—notable the huge buildup in housing debt, which left many homeowners underwater on their mortgages or otherwise wealth constrained. But saying it “wasn’t really an aggregate demand crisis but a financial crisis” is like saying “this man doesn’t have blood loss, he has a gunshot wound!”

Furthermore, it is true that the Fed did flood the zone with liquidity, but they also let inflation expectations crash in late 2008, a classic sign of a collapse in aggregate demand—as if you have less spending, you’ll have less bidding on goods and services and prices will fall to compensate. And they not only failed to push inflation back to level until 2010, they didn’t give us the period of catch-up price level increase that would have been justified by such a long period of undershooting.

So, Professor Sachs, what did cause the enormous collapse in GDP pictured above? The Great Vacation theory, what?

Ryan Cooper is a National Correspondent at The Week, and a former web editor of the Washington Monthly. Find him on Twitter: @ryanlcooper


  • Peter K. on March 12, 2013 11:51 AM:

    Agree with you about Sachs and in general but I still have a hard time nailing down a complete narrative of what happened. Dean Baker makes a compelling argument to focus more on the housing bubble which caused the financial crisis. The bubble is often left out of narratives about the financial crisis.

    Imagine an alternate timeline where Lehman was bailout out and there was no panic. Or maybe something else would cause the panic. How would repeated bailouts go down? No Lehman, no TARP?

    On the one hand I find Baker's argument convincing that the loss of demand from the collapse of the bubble would have brought the economy down sooner or later. On the other hand there was a bank run per Gorton which made things worse and just as we had an unsustainable bubble built on greed, we then had the "obverse" of a bubble based on fear.