It may seem like these two worlds won’t matter much in five years. Certainly deficits will be higher in the second, GDP lower, workers less safe, but eventually, the economy will bounce back. A new paper by Dave Reifschneider, William L. Wascher and David Wilcox argues the opposite: the prolonged downturn following the “Great Recession” has likely caused long-term economic damage. The paper is primarily about the implications for monetary policy, since it’s written by three members of the Federal Reserve Board, but the most important point is that the recession has done permanent damage to the economy. In economic jargon, what the economists describe is “hysteresis,” which first came from a 1986 paper by Oliver Blanchard and Lawrence Summers entitled, “Hysteresis and the European Unemployment Problem,” in which the authors argue that large demand contractions can have long-term effects on unemployment and economic growth. Policymakers should intervene to prop up demand to limit long-term damage to the supply side of the economy. As Gavyn Davis notes in the Financial Times, the implication is that, “In a reversal of Say’s Law, and also a reversal of most US macro-economic thinking since Friedman, demand creates its own supply.”
Posted on: Fri, 15 Nov 2013 16:55:59 +0000
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