Sunday, December 18, 2011

We Have A Balance Sheet Recession So We Should Repair Household Balance Sheets

The article that I posted below describes some research on the relationship between household debt and the fall in aggregate demand that has led to persistently high unemployment. This article is an interview with one of the authors of that study. It goes into more depth on the issues related to the study. I suggest that you read that article before reading this interview.

One of the authors of the study is from the University of Chicago that favors neo-classical explanations of economic phenomena. Their criticism of the study is based upon how neo-classical equilibrium should be reached without government intervention. They argue that interest rates will fall in response to the low levels of savings, and that should reduce savings and stimulate consumption. But nominal interest rates are already close to zero and that has not happened. They would have to fall even further in order to achieve equilibrium, and that is not possible. This is the liquidity trap problem.

Paul Krugman uses the liquidity trap argument to make a similar point but he recommends an increase in government spending to compensate for the decline in consumption. They disagree with Krugman on how to respond to the problem. They believe that we should deal directly with the cause of the problem. If household debt is responsible for declining demand and high unemployment, we should focus on principle reduction and other means to reduce household debt.

The interviewer raises a number of good questions and the responses are also very interesting. I recommend a careful reading of the interview after reading the summary of the research posted below.

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