Moreover, our analysis shows that the cumulative income generated over the period in which the balance sheet has been unusually large is likely to exceed normal levels under a wide range of scenarios. In my view, while the costs are real and need to be carefully evaluated, they pale relative to the costs of not achieving a sustainable economic recovery. A failure in that regard would lead to widespread chronic unemployment. Not only would that be tragic for millions of people, but it also would generate chronic shortfalls in the nation’s potential output and fiscal capacity. Relative to the costs outlined above, the benefits from avoiding such an outcome seem overwhelming. Cyclical and structural policy Although I favor an aggressive monetary policy in the current situation, I also recognize that monetary policy is not a panacea. We all know that in the long run money is neutral – that is, that while monetary policy can help the economy return to full employment following a shock, the full employment level of output, employment and real income depends on factors outside of monetary policy. Also, we must recognize that the strength of the current cyclical recovery will depend importantly on non-monetary policy choices. Other steps are needed to secure the best available economic outcome.
When the bust arrives, over-indebted households and businesses want to increase their saving and liquidity buffers, and financial intermediaries want to raise credit standards. Both responses restrain demand and make a cyclical rebound more difficult. In the U.S. case, because the bust was concentrated in housing, the scope for a strong cyclical recovery was particularly constrained because the interest-rate sensitive sector that would typically lead such a rebound could not recover until the overhang of unsold homes and the impairment of housing finances was corrected. The U.S. recovery has also been subpar because it has been taking place in the context of a weak global economy. Historically, after a country experienced a financial crisis, growing foreign demand and currency depreciation have often led to a sharp improvement in the trade account that has put a floor under economic activity. In such circumstances, rising exports substitute for domestic consumption in supporting aggregate demand. This demand, in turn, encourages businesses to hire and invest. In contrast, this time the shock generated by the U.S. housing bust had global consequences, exposing economic vulnerabilities outside of the United States, especially in Europe. Under these circumstances, the scope for trade as a support for U.S. growth, while positive, has been very limited. These two factors – the dynamics following financial crises and the weakness of foreign demand – help explain why U.S. growth has been weak, but I don’t think these factors explain why it has been consistently weaker than expected.