Secular StagnationWhy Might Equilibriu.docx

Secular Stagnation
Why Might Equilibrium Real Rates Have Fallen?
Increased Savings
Changes in distribution of income and profits share
Reserve accumulation or capital flight
Increasing deleveraging and retirement preparation
Decreases in Investment Propensity
Declining growth rate of population and/or technology
Demassification of the economy
Fall in price of capital goods
Other factors
Increased global save asset demand

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Lawrence H.
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and President
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served as the 71st Secretary of the
Treasury for President Clinton and
the Director of the National Economic
Council for President Obama.
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Summers published an article title, “The Age of Secular
Stagnation: What It Is and What to Do About It,” in the

February
issue of Foreign A�airs. The article explores how expansionary
�scal policy by the U.S. government can help overcome secular
stagnation problems and get growth back on track.
The Age of Secular Stagnation: What It Is and What to Do
About It
February 15, 2016
published in Foreign A�airs
As surprising as the recent �nancial crisis [1] and recession
were, the behavior of the
world’s industrialized economies and �nancial markets during
the recovery [2] has been
even more so.
Most observers expected the unusually deep recession to be
followed by an unusually
rapid recovery, with output and employment returning to trend
levels relatively quickly.
Yet even with the U.S. Federal Reserve [3]’s aggressive
monetary policies, the recovery
(both in the United States and around the globe) has fallen
signi�cantly short of
predictions and has been far weaker than its predecessors [4].
Had the American
economy performed as the Congressional Budget O�ce fore cast
in August 2009—after
the stimulus had been passed and the recovery had started—U.S.
GDP today would be
about $1.3 trillion higher than it is.
Almost no one in 2009 imagined that U.S. interest rates would
stay near zero for six

years, that key interest rates in Europe would turn negative, and
that central banks in the
G-7 would collectively expand their balance sheets by more
than $5 trillion. Had
economists been told such monetary policies lay ahead,
moreover, they would have
con�dently predicted that in�ation would become a serious
problem—and would have
been shocked to �nd out that across the United States, Europe,
and Japan, it has
generally remained well below two percent.
In the wake of the crisis, governments’ debt-to-GDP ratios have
risen sharply, from 41
percent in 2008 to 74 percent today in the United States, from
47 percent to 70 percent
in Europe, and from 95 percent to 126 percent in Japan. Yet
long-term interest rates are
still remarkably low, with ten-year government bond rates at
around two percent in the
United States, around 0.5 percent in Germany, and around 0.2
percent in Japan as of the
beginning of 2016. Such low long-term rates suggest that
markets currently expect both
low in�ation and low real interest rates to continue for many
years. With appropriate
caveats about the complexities of drawing inferences from
indexed bond markets, it is
fair to say that in�ation for the entire industrial world is
expected to be close to one
percent for another decade and that real interest rates are
expected to be around zero
over that time frame. In other words, nearly seven years into the
U.S. recovery, markets
are not expecting “normal” conditions to return anytime soon.

The key to understanding this situation lies in the concept of
secular stagnation [5], �rst
put forward by the economist Alvin Hansen in the 1930s. The
economies of the industrial
world, in this view, su�er from an imbalance resulting from an
increasing propensity to
save and a decreasing propensity to invest. The result is that
excessive saving acts as a
drag on demand, reducing growth and in�ation, and the
imbalance between savings and
investment pulls down real interest rates. When signi�cant
growth is achieved,
meanwhile—as in the United States between 2003 and 2007—it
comes from dangerous
levels of borrowing that translate excess savings into
unsustainable levels of investment
(which in this case emerged as a housing bubble).
Other explanations for what is happening have been proposed,
notably Kenneth Rogo�’s
theory of a debt overhang, Robert Gordon [6]’s theory of
supply-side headwinds, Ben
Bernanke’s theory of a savings glut [7], and Paul Krugman’s
theory of a liquidity trap. All
of these have some validity, but the secular stagnation theory
o�ers the most
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comprehensive account of the situation and the best basis for
policy prescriptions. The
good news is that although developments in China [8] and
elsewhere raise the risks that
global economic conditions will deteriorate, an expansionary
�scal policy by the U.S.
government can help overcome the secular stagnation problem
and get growth back on
track.
STUCK IN NEUTRAL
Just as the price of wheat adjusts to balance the supply of and
demand for wheat, it is
natural to suppose that interest rates—the price of money—
adjust to balance the supply
of savings and the demand for investment in an economy.
Excess savings tend to drive
interest rates down, and excess investment demand tends to
drive them up. Following
the Swedish economist Knut Wicksell, it is common to refer to
the real interest rate that
balances saving and investment at full employment as the
“natural,” or “neutral,” real
interest rate. Secular stagnation occurs when neutral real
interest rates are su�ciently
low that they cannot be achieved through conventional central-
bank policies. At that
point, desired levels of saving exceed desired levels of
investment, leading to shortfalls in
demand and stunted growth.
This picture �ts with much of what we have seen in recent
years. Real interest rates are
very low, demand has been sluggish, and in�ation is low, just
as one would expect in the

presence of excess saving. Absent many good new investment
opportunities, savings
have tended to �ow into existing assets, causing asset price
in�ation.
For secular stagnation to be a plausible hypothesis, there have
to be good reasons to
suppose that neutral real interest rates have been declining and
are now abnormally
low. And in fact, a number of recent studies have tried to look
at this question and have
generally found declines of several percentage points. Even
more convincing is the
increasing body of evidence suggesting that over the last
generation, various factors
have increased the propensity of populations in developed
countries to save and
reduced their propensity to invest. Greater saving has been
driven by increases in
inequality and in the share of income going to the wealthy,
increases in uncertainty
about the length of retirement and the availability of bene�ts,
reductions in the ability to
borrow (especially against housing), and a greater accumulation
of assets by foreign
central banks and sovereign wealth funds. Reduced investment
has been driven by
slower growth in the labor force, the availability of cheaper
capital goods, and tighter
credit (with lending more highly regulated than before).
Perhaps most important, the new economy [9] tends to conserve
capital. Apple and
Google, for example, are the two largest U.S. companies and are
eager to push the
frontiers of technology [10] forward, yet both are awash in cash

and are under pressure
to distribute more of it to their shareholders. Think about
Airbnb’s impact on hotel
construction, Uber’s impact on automobile demand, Amazon’s
impact on the
construction of malls, or the more general impact of information
technology on the
demand for copiers, printers, and o�ce space. And in a period
of rapid technological
change, it can make sense to defer investment lest new
technology soon make the old
obsolete.
Various studies have explored the impact of these factors and
attempted to estimate the
extent to which they have reduced neutral real interest rates.
The most recent and
thorough of these, by Lukasz Rachel and Thomas Smith at the
Bank of England,
concluded that for the industrial world, neutral real interest
rates have declined by about
4.5 percentage points over the last 30 years and are likely to
stay low in the future.
Together with the current price of long-term bonds, this
suggests that the kind of Japan-
style stagnation that has plagued the industrial world in recent
years may be with us for
quite some time.
DIFFERENTIAL DIAGNOSIS
Not all economists are sold on the secular stagnation
hypothesis. Building on the
monumental history of �nancial crises he wrote with Carmen
Reinhart, for example,
Rogo� ascribes current di�culties to excessive debt buildups

and subsequent
deleveraging. But although these surely contributed to the
�nancial crisis, they seem
insu�cient to account for the prolonged slow recovery.
Moreover, the debt buildups
theory provides no natural explanation for the generation-long
trend toward lower
neutral real interest rates. It seems more logical to see the debt
buildups decried by
Rogo� as not simply exogenous events but rather the
consequence of a growing excess
of saving over investment and the easy monetary policies
necessary to maintain full
employment.
https://www.foreignaffairs.com/articles/china/2016-01-11/end-
chinas-rise
https://www.foreignaffairs.com/articles/2015-12-12/fourth-
industrial-revolution
https://www.foreignaffairs.com/reviews/review-essay/thinkers-
and-tinkerers
3/6
Gordon, meanwhile, has argued for what might be called
supply-side secular stagnation
—a fundamental decline in the rate of productivity growth
relative to its golden age,
from 1870 to 1970. Gordon is likely right that over the next
several years, the growth in
the potential output of the American economy and in the real
wages of American

workers will be quite slow. But if the primary culprit were
declining supply (as opposed
to declining demand), one would expect to see in�ation
accelerate rather than
decelerate.
For a decade, Bernanke has emphasized the idea of a savings
glut emanating from cash
thrown o� by emerging markets. This was indeed an important
factor in adding to
excess saving in the developed world a decade ago, and it may
well be again if emerging
markets continue to experience growing capital �ight. But both
the timing and the scale
of capital export from emerging markets make it unlikely that it
is the principal reason
for the major recent declines in neutral real interest rates.
Krugman and some others have sought to explain recent events
and make policy
recommendations based on the old Keynesian concept of
a liquidity trap [11]. As
Krugman has emphasized, this line of thinking is parallel to the
secular stagnation one.
But most treatments of the liquidity trap treat it as a temporary
phenomenon rather
than a potentially permanent state of a�airs, which is what the
evidence seems to be
showing.
Perhaps the most comforting alternative view is that secular
stagnation may have indeed
occurred in the past but is no longer operating in the present.
With the unemployment
rate down to �ve percent and the Fed embarked on a tightening
cycle, the argument

runs, indicators will start returning to earlier, higher growth
trends. Perhaps. But
markets are betting that the Fed will not be able to tighten
monetary policy nearly as
much as it expects, and if another recession starts in the next
few years, cuts will soon
bring interest rates back down to the zero lower bound.
LET’S GET FISCAL
Up to the 1970s, most economists believed that if governments
managed demand
properly, their countries’ economies could enjoy low
unemployment and high output
with relatively modest in�ation. The proper task of
macroeconomists, it followed, was to
use monetary and �scal policy to manage demand well. But this
thinking was eventually
challenged from two directions—in theory, by Milton
Friedman [12], Robert Lucas, and
others, and in practice, by the experience of high in�ation
together with high
unemployment.
The emergence of such “stag�ation” in the late 1970s [13] led
to general acceptance of
the natural-rate hypothesis, the idea that abnormally low
unemployment causes
in�ation to accelerate. According to this view, since
policymakers would not accept
permanently rising rates of in�ation, economies would tend to
�uctuate around a
natural rate of unemployment, determined by factors such as
labor �exibility, the
availability of bene�ts, and the e�ectiveness of hiring and job
searches. By skillfully

managing demand, policymakers could aspire to reduce the
amplitude of the
�uctuations—and although they could determine the average
rate of in�ation, they
could not raise the average level of output.
By the mid 1980s, once in�ation had been brought down from
double-digit levels, a
consensus on macroeconomic policy emerged. The central
objective of policy, most
mainstream economists believed, should be to achieve a low and
relatively stable rate of
in�ation, since there were no permanent gains to be had from
higher in�ation. This
could best be accomplished, it was thought, by �rmly
establishing the political
independence of central banks and by setting in�ation targets in
order to control
expectations. Fiscal policy, meanwhile, was not considered to
have a primary role in
managing demand, because it was slow acting and might push
interest rates up and
because monetary policy could do what was needed.
Seen through the lens of the secular stagnation hypothesis,
however, all these
propositions are problematic. If it were possible to avoid
secular stagnation, then it
would indeed be possible to increase average levels of output
substantially, raising the
stakes for demand management policy. The danger in monetary
policy, moreover, lies
not in politicians eager to in�ate away problems but in bankers
refusing to generate
enough demand to bring in�ation up to target levels and permit
reductions in real

interest rates. And �scal policy, �nally, takes on new
signi�cance as a tool in economic
stabilization.
http://krugman.blogs.nytimes.com/2013/04/11/monetary-policy-
in-a-liquidity-trap/?_r=0
https://www.foreignaffairs.com/reviews/capsule-review/2007-
05-01/milton-friedman-biography
01/stagflation-how-we-got-it-how-get-out
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As of yet, none of these principles has been fully accepted by
policymakers in the
advanced industrial world. It is true that central banks have
sought, through quantitative
easing, to loosen monetary conditions even with short-term
interest rates at rock
bottom. But they have treated these policies as a short-term
expedient, not a longer-
term necessity. More important, these policies are running into
diminishing returns and
giving rise to increasingly toxic side e�ects. Sustained low
rates tend to promote excess
leverage, risk taking, and asset bubbles.
This does not mean that quantitative easing was mistaken.
Without such policies, output
would likely be even lower, and the world economy might well
have tipped into de�ation.
But monetary-policy makers need to acknowledge much more

explicitly that neutral real
rates have fallen substantially and that the task now is to adjust
policy accordingly. This
could include setting targets for nominal GDP growth rather
than in�ation, investing in a
wider range of risk assets, making plans to allow base rates to
turn negative, and
underscoring the importance of avoiding a new recession.
When the primary policy challenge for central banks was
establishing credibility that the
printing press was under control, it was appropriate for them to
jealously guard their
independence. When the challenge is to accelerate, rather than
brake, economies, more
cooperation with domestic �scal authorities and foreign
counterparts is necessary.
The core problem of secular stagnation is that the neutral real
interest rate is too low.
This rate, however, cannot be increased through monetary
policy. Indeed, to the extent
that easy money works by accelerating investments and pulling
forward demand, it will
actually reduce neutral real rates later on. That is why primary
responsibility for
addressing secular stagnation should rest with �scal policy. An
expansionary �scal policy
can reduce national savings, raise neutral real interest rates, and
stimulate growth.
Fiscal policy has other virtues as well, particularly when
pursued through public
investment. A time of low real interest rates, low materials
prices, and high construction
unemployment is the ideal moment for a large public investment

program. It is tragic,
therefore, that in the United States today, federal infrastructure
investment, net of
depreciation, is running close to zero, and net government
investment is lower than at
any time in nearly six decades.
It is true that an expansionary �scal policy would increase
de�cits, and many worry that
running larger de�cits would place larger burdens on later
generations, who will already
face the challenges of an aging society. But those future
generations will be better o�
owing lots of money in long-term bonds at low rates in a
currency they can print than
they would be inheriting a vast deferred maintenance liability.
Traditional concern with �scal de�cits has focused on their
impact in pushing up interest
rates and retarding investment. Yet by setting yields so low and
bond prices so high,
markets are sending a clear signal that they want more, not less,
government debt. By
stimulating growth and enabling an in�ation increase that
would permit a reduction in
real capital costs, �scal expansion now would crowd investment
in rather than out. Well-
intentioned proposals to curtail prospective pension bene�ts, in
contrast, might make
matters even worse by encouraging increased saving and
reduced consumption, thus
exacerbating secular stagnation.
The main constraint on the industrial world’s economy today is
on the demand, rather
than the supply, side. This means that measures that increase

potential supply by
promoting �exibility are therefore less important than measures
that o�er the potential
to increase demand, such as regulatory reform and business tax
reform. Other structural
policies that would promote demand include steps to accelerate
investments in
renewable technologies that could replace fossil fuels and
measures to raise the share of
total income going to those with a high propensity to consume,
such as support for
unions and increased minimum wages. Thus, John Maynard
Keynes, writing in a similar
situation during the late 1930s, rightly emphasized the need for
policy approaches that
both promoted business con�dence—the cheapest form of
stimulus—and increased
labor compensation.
TO HANGZHOU AND BEYOND
If each of the countries facing secular stagnation today were to
confront it successfully
on its own, the results would be very favorable for the global
economy. But international
focus and coordination have crucial additional roles to play.
Secular stagnation, after all, increases the contagion from
economic weakness. In normal
times, if the rest of the world economy su�ers, the United
States or any other a�ected

5/6
economy can o�set the loss of demand and competitiveness
through monetary easing.
With monetary policy already at its lower limit, however,
additional easing is impossible
(or at least much more di�cult), and so each country’s stake in
the strength of the global
economy is greatly magni�ed.
Secular stagnation also increases the danger of competitive
monetary easing and even
of currency wars. Looser money, starting with near-zero capital
costs, is likely to
generate demand primarily through increases in
competitiveness. This is a zero-sum
game, since currency movements switch demand from one
country to another rather
than increase it globally. Fiscal expansions, in contrast, raise
demand on a global basis.
International coordination is thus necessary to avoid an
excessive and self-defeating
reliance on monetary policy and achieve a mutually rewarding
reliance on �scal policy to
address problems.
Movements in commodity prices in recent months have shown
that events in emerging
markets, especially China, can have signi�cant impacts
globally. It now appears likely that
more capital will �ow out of emerging markets and less will
�ow in than has been the
case in recent years. These capital out�ows and the consequent
increases in net exports
will further reduce demand and neutral real rates in the

developed world, thereby
exacerbating secular stagnation. Policies that help restore
con�dence in emerging
markets, therefore, will also strengthen the global economy.
These issues were recognized at the successful G-20 summit in
London in April 2009
(although the problems were misdiagnosed as cyclical and
temporary rather than
secular and enduring). The common commitments undertaken
there to engage in �scal
expansion, strengthen �nancial regulation, resist trade
protection, and enhance the
capacity of international �nancial institutions to respond to
problems in emerging
markets were e�ective in halting the collapse of the global
economy. Unfortunately,
subsequent G-20 summits returned to their traditional lethargy
and misguided
preoccupation with �scal austerity, monetary normalization,
and moral hazard, ending
up missing opportunities to accelerate the recovery.
This year, the Chinese will host a G-20 summit in September. If
China chooses to
recognize how important global growth is for its economy, and
how important its
economy is for global growth, it could perform a great service
by reinvigorating
international economic cooperation. The key priority in
Hangzhou—as it was in London
back in 2009—should be increasing global demand and making
sure that it picks up
particularly in those countries where there is the most economic
slack.

In this regard, China’s decisions about its own economic a�airs
will be crucial. To date,
the international community has joined Chinese �nancial
o�cials in urging China’s
political leadership to pursue �nancial liberalization. This is
surely correct for the long
run. But it may well be in China’s and the global interest that
the liberalization process
proceed more gradually than is currently envisioned, so that
capital out�ows from China
do not threaten China’s own �nancial stability and spread
weakness to the global
economy at large.
As the euro has declined sharply, meanwhile, any recovery that
Europe has achieved has
come largely from increases in competitiveness that reduce
growth elsewhere. Germany
now leads the world with a trade surplus equal to a whopping
eight percent of GDP. The
global community should encourage Europe to generate
domestic demand as it seeks to
expand its economy.
One more priority in Hangzhou should be promoting global
infrastructure investment. In
this regard, the Chinese-led Asian Infrastructure Investment
Bank [14] is a valuable step
forward, and it should be strongly supported by the global
community, even as it is
encouraged to respect international norms and standards relating
to issues such as
environmental protection and integrity in procurement. And
e�orts to support
infrastructure investment elsewhere, such as the Obama
administration’s Power Africa

initiative, should be carried forward.
Secular stagnation and the slow growth and �nancial instability
associated with it have
political as well as economic consequences. If middle-class
living standards were
increasing at traditional rates, politics across the developed
world would likely be far
less surly and dysfunctional. So mitigating secular stagnation is
of profound importance.
Writing in 1930, in circumstances far more dire than those we
face today, Keynes still
managed to summon some optimism. Using a British term for a
type of alternator in a
car engine, he noted that the economy had what he called
“magneto trouble.” A car with
a broken alternator won’t move at all—yet it takes only a simple
repair to get it going. In
https://www.foreignaffairs.com/articles/china/2015-05-07/whos-
afraid-aiib
6/6
© LAWRENCE H. SUMMERS, 2019
much the same way, secular stagnation does not reveal a
profound or inherent �aw in
capitalism. Raising demand is actually not that di�cult, and it is
much easier than raising
the capacity to produce. The crucial thing is for policymakers to

diagnose the problem
correctly and make the appropriate repairs.
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states/2016-02-15/age-
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economists-learn
[2] https://www.foreigna�airs.com/reviews/review-
essay/second-great-depression
[3] https://www.foreigna�airs.com/articles/united-states/2012-
04-23/all-presidents-
central-bankers
06-29/america-s-weak-
recovery
[5]
stagnation-graphics
[6] https://www.foreigna�airs.com/reviews/review-essay/2016-
01-28/innovation-over
[7] http://www.brookings.edu/blogs/ben-
bernanke/posts/2015/04/01-why-interest-rates-
low-global-savings-glut
[8] https://www.foreigna�airs.com/articles/china/2016-01-
11/end-chinas-rise

[9] https://www.foreigna�airs.com/articles/2015-12-12/fourth-
industrial-revolution
[10] https://www.foreigna�airs.com/reviews/review-
essay/thinkers-and-tinkerers
[11] http://krugman.blogs.nytimes.com/2013/04/11/monetary-
policy-in-a-liquidity-trap/?
_r=0
[12] https://www.foreigna�airs.com/reviews/capsule-
review/2007-05-01/milton-
friedman-biography
09-01/stag�ation-how-
we-got-it-how-get-out
[14] https://www.foreigna�airs.com/articles/china/2015-05-
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1/22/2018 The Great Recession: A Macroeconomic Earthquake |
Federal Reserve Bank of Minneapolis
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The Great Recession: A Macroeconomic
Earthquake
Why it happened, endured and wasn’t foreseen. And how it’s
changing theory
Lawrence J. Christiano | Consultant
Published February 7, 2017
Economic Policy Papers are based on policy-oriented research
produced by Minneapolis Fed staff and consultants. The
papers are an occasional series for a general audience. The
views expressed here are those of the authors, not necessarily
those of others in the Federal Reserve System.
Executive Summary
The Great Recession was particularly severe and has endured

far
longer than most recessions. Economists now believe it was
caused by a perfect storm of declining home prices, a financial
system heavily invested in house-related assets and a shadow
banking system highly vulnerable to bank runs or rollover risk.
It
has lasted longer than most recessions because economically
damaged households were unwilling or unable to increase
spending, thus perpetuating the recession by a mechanism
known
as the paradox of thrift. Economists believe the Great Recession
wasn’t foreseen because the size and fragility of the shadow
banking system had gone unnoticed.
The recession has had an inordinate impact on macroeconomics
as a discipline, leading economists to reconsider two largely
discarded theories: IS-LM and the paradox of thrift. It has also
forced theorists to better understand and incorporate the
financial
sector into their models, the most promising of which focus on
mismatch between the maturity periods of assets and liabilities
held by banks.
Introduction
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The Great Recession struck individuals, the aggregate economy
and the economics profession like an earthquake, and its
aftershocks are still being felt. Job losses and housing
foreclosures devastated many families. National economies
were

deeply damaged and have yet to fully recover. And
economists—
who failed to predict either the crisis or the recession— have
been
struggling to understand why they didn’t grasp the fragility of
the
financial system and the duration of the recession.
This essay briefly discusses why the Great Recession is
considered both “Great” and a “Recession.” It then turns to the
emerging consensus about its cause, its duration and the reasons
so few predicted it. Finally, it explores the impact of the Great
Recession on how academic economists now think about the
economy.
“Great Recession”
The economic downturn the United States suffered from late
2007
to the third quarter of 2009 was particularly damaging. Output,
consumption, investment, employment and total hours worked
dropped far more during the recent recession than the
comparable average figures for all other recessions since 1945.
Employment, for example, dropped 6.7 percent during the 2007-
09 recession compared with an average of 3.8 percent for
postwar recessions. Analogous figures for output: 7.2 percent
and
4.4 percent; for consumption: 5.4 percent and 2.1 percent. That
higher level of severity across the board is why this recession
has
earned the adjective “Great.”
By the same token, however, this recession was definitely not
the
worst U.S. downturn on record. Conditions were far worse
during
the Great Depression. Employment fell 27 percent from 1929 to

1933 (compared with 6.7 percent from 2007 to 2009), output
fell
36 percent (7.2 percent) and consumption fell 23 percent (5.4
percent). For that reason, the recent slump, though severe, is
rightly considered a recession rather than a full-bore depression.
Another reason to consider this recession “Great” is how
uncommonly long the economy has been taking to recover. The
accompanying figure displays labor productivity (output per
working-age person, adjusted for inflation) from 1977 through
2014. The vertical pink bars in the figure indicate the starting
and
ending dates for recessions, as determined by the National
Bureau of Economic Research (NBER).
1
The U.S. economy did not return to the 2007 level of output per
capita until a little over five years later, in first quarter 2013.
The
productivity trend lines for the previous four recessions show
that
the economy usually snaps back more quickly. Even now, the
U.S. economy is still about 10 percent below normal (that is,
trend
growth in 2007).
What caused the Great Recession?

Conventional wisdom is now converging on a particular
narrative
about the cause of the Great Recession. In effect, the Great
Recession was a “perfect storm” created by the concurrence of
three factors. Taken by itself, none of these factors would have
caused a major recession, but in combination, they were
explosive.
The first was the decline in housing prices that began in the
summer of 2007. Whether this was the end of a “bubble” or just
an ordinary fluctuation does not matter for the narrative. The
second factor was that the financial system was heavily invested
in housing-related assets, mortgage-backed securities. The third
factor was that the shadow banking system was invested in
housing assets and highly vulnerable to bank runs.
These three factors are the essential elements in the following
narrative about the Great Recession.
The fall in housing prices damaged the assets of the shadow
banking system and thereby created the conditions in which a
run
on the shadow banking system could occur. Alas, a run did
occur
in the summer of 2007, forcing the shadow banking system to
sell
its assets at fire sale prices.
This asset decline damaged the whole banking system and
hindered its ability to intermediate not just house purchases, but
investment more generally. With reduced credit, purchases of
houses declined and the fall in house prices was reinforced.
By reducing household wealth, the fall in house prices induced
households to cut back on spending. Faced with declining sales,
firms pulled back on investment and hiring. All of these factors

reinforced each other, sending the economy into the tailspin
documented above.
2
3
4
5
6
Why has it lasted so long?
The conventional view on why the recession lasted so long is
that
the events described in the previous paragraph reinforced the
desire to save, relative to the desire to invest. If markets worked
efficiently, then the interest rate would have fallen to balance
the
demand and supply of savings, without a significant fall in
employment. According to the conventional view, this required
that interest rates be substantially negative, something that
could
not be achieved because the nominal interest rate cannot be
much below zero. Because interest rates could not fall enough
to
clear lending markets, something else had to bring the demand

and supply of saving into equality. That something else was the
fall in aggregate output and income, which allowed lending
markets to clear by reducing saving as people tried to avoid
reducing their consumption too much. This is essentially the
logic
of the “paradox of thrift” analyzed in undergraduate textbooks
in
macroeconomics. Consistent with those textbooks, the fall in
output arising from this paradox-of-thrift reasoning could in
principle last for a long time.
Why didn’t policymakers or economists see it coming?
The emerging consensus is that no one, neither policymakers
nor
academic economists, was aware of the third factor underlying
the
Great Recession, the size and fragility of the shadow banking
sector (see, for example, Bernanke 2010). The reason is simple.
Much of what policymakers and economists know about
financial
markets comes about as a side effect of regulation, and the
shadow banking system existed mostly outside the normal
regulatory framework.
Impact on macroeconomics
The Great Recession is having an enormous impact on
macroeconomics as a discipline, in two ways. First, it is leading
economists to reconsider two theories that had largely been
discredited or neglected. Second, it has led the profession to
find
ways to incorporate the financial sector into macroeconomic
theory.
Neglected paradigms
At its heart, the narrative described above characterizes the
Great

Recession as the response of the economy to a negative shock to
the demand for goods all across the board. This is very much in
the spirit of the traditional macroeconomic paradigm captured
by
the famous IS-LM (or Hicks-Hansen) model, which places
demand shocks like this at the heart of its theory of business
cycle
fluctuations. Similarly, the paradox-of-thrift argument is also
expressed naturally in the IS-LM model.
The IS-LM paradigm, together with the paradox of thrift and the
notion that a decision by a group of people could give rise to a
welfare-reducing drop in output, had been largely discredited
among professional macroeconomists since the 1980s. But the
Great Recession seems impossible to understand without
invoking paradox-of-thrift logic and appealing to shocks in
aggregate demand. As a consequence, the modern equivalent of
the IS-LM model—the New Keynesian model—has returned to
center stage. (To be fair, the return of the IS-LM model began
in
7
8
9
10
11
12

the late 1990s, but the Great Recession dramatically accelerated
the process.)
The return of the dynamic version of the IS-LM model is
revolutionary because that model is closely allied with the view
that the economic system can sometimes become dysfunctional,
necessitating some form of government intervention. This is a
big
shift from the dominant view in the macroeconomics profession
in
the wake of the costly high inflation of the 1970s. Because that
inflation was viewed as a failure of policy, many economists in
the
1980s were comfortable with models that imply markets work
well
by themselves and government intervention is typically
unproductive.
Accounting for the financial sector
The Great Recession has had a second important effect on the
practice of macroeconomics. Before the Great Recession, there
was a consensus among professional macroeconomists that
dysfunction in the financial sector could safely be ignored by
macroeconomic theory. The idea was that what happens on Wall
Street stays on Wall Street—that is, it has as little impact on the
economy as what happens in Las Vegas casinos. This idea
received support from the U.S. experiences in 1987 and the
early
2000s, when the economy seemed unfazed by substantial stock
market volatility. But the idea that financial markets could be
ignored in macroeconomics died with the Great Recession.

Now macroeconomists are actively thinking about the financial
system, how it interacts with the broader economy and how it
should be regulated. This has necessitated the construction of
new models that incorporate finance, and the models that are
empirically successful have generally integrated financial
factors
into a version of the New Keynesian model, for the reasons
discussed above. (See, for example, Christiano, Motto and
Rostagno 2014.)
Economists have made much progress in this direction, too
much
to summarize in this brief essay. One particularly notable set of
advances is seen in recent research by Mark Gertler, Nobuhiro
Kiyotaki and Andrea Prestipino. (See Gertler and Kiyotaki 2015
and Gertler, Kiyotaki and Prestipino 2016.) In their models,
banks
finance long-term assets with short-term liabilities. This
liquidity
mismatch between assets and liabilities captures the essential
reason that real world financial institutions are vulnerable to
runs.
As such, the model enables economists to think precisely about
the narrative described above (and advocated by Bernanke 2010
and others) about what launched the Great Recession in 2007.
Refining models of this kind is essential for understanding the
root
causes of severe economic downturns and for designing
regulatory and other policies that can prevent a recurrence of
disasters like the Great Recession.
Endnotes
1 The output and population data were obtained from FRED, the
online database maintained by the Federal Reserve Bank of St.

Louis. The FRED label for the output measure is GDPC1, and
the
label for the working-age population is LFWA64TTUSQ647S.
2 The exact amount of time required for per capita output to
return
to its prerecession peak depends somewhat on the population
measure used. If instead the civilian non-institutional
population
measure (FRED label CNP16OV) were used, then the amount of
time would have been longer, roughly seven years. The
difference
from the results in the figure reflects demographic factors that
cause the working-age population to grow less rapidly than the
population as a whole.
3 For additional discussion about the trend of U.S. economic
output in 2007, see Christiano, Eichenbaum and Trabandt
(2015).
The 10 percent number in the text was rounded after doing the
following calculations. I fit a linear time trend to the natural
logarithm of the output measure in the figure, using data from
the
beginning of the sample to the fourth quarter of 2007, the
quarter
before the Great Recession began according to the NBER. I
extended the trend to the end of the sample. The difference
between the trend at the end of the sample and the (log of the)

last data point is 0.136, which I rounded to 0.10. The 10 percent
number reported in the text is the last number, multiplied by
100.
4 An early, subsequently discarded, view was the so-called
labor
mismatch hypothesis. It held that the low level of employment
was
not due to a lack of jobs, but to the lack of workers with the
right
skills to fill them. Workforce and firms were “mismatched.”
This view lost its appeal as it became apparent just how broad-
based the recession was. Employment and hours worked fell in
virtually all sectors. The unemployment rate jumped for
virtually
every type of worker, by level of education and occupation.
According to the mismatch hypothesis, wage growth should
have
been especially high and unemployment low for the highly
sought-
after types of workers. But jobs were scarce virtually
everywhere,
for everyone.
Why did employers hire so few workers? Since the early 1970s,
the National Federation of Independent Business has surveyed
its
members to find out what their top problem is. They are asked
to
select from among 10 possibilities, including taxes, inflation,
poor
sales and quality of labor. Under the mismatch hypothesis, a
large
fraction of firms should have selected “quality of labor” as their
top

problem. They didn’t. Instead, “poor sales” surged beyond all
other options as their top problem. Firms were not hiring simply
because people were not buying their goods and services.
5 It is an interesting story, beyond the scope of this analysis,
how
so much money came to be invested in mortgages. Under the
conventional view, the source of the money was what Bernanke
(2005) called the “savings glut”: Money poured in from high-
saving countries in Asia and oil-producing regions. Under what
Shin (2012) called the “banking glut,” a lot of that incoming
money
went to Europe and then came right back to the United States.
The European institutions that managed this back-and-forth
flow
had a strong preference for mortgages.
Evidence in favor of the notion that the large current account
deficit reflected an increase in the supply of funds by foreigners
is
the sharp drop in interest rates since 2000. The evidence that a
lot of the extra money went into mortgages is that mortgage
rates
and lending conditions became particularly loose. For further
discussion of this view, see Justiniano, Primiceri and
Tambalotti
(2015). Evidence consistent with the notion that the U.S.

current
account deficit played an important role in housing markets can
also be seen in the substantial covariation between U.S. housing
prices and the current account (see Figure 1.1 in Justiano,
Primiceri and Tambalotti 2015).
6 Technically, what happened was a rollover crisis, not a
traditional bank run like those familiar from movies and
photographs from the Great Depression. For a careful discussion
of a rollover crisis, see Gertler and Kiyotaki (2015).
7 The paradox-of-thrift argument described in the text lies at
the
heart of the analysis of the interest rate lower bound in
Eggertsson and Woodford (2003).
8 That shadow banking system was of a similar order of
magnitude as the traditional banking system discussed in
Geithner (2008).
9 The IS-LM model—often depicted graphically and thought to
encapsulate traditional Keynesian theory—describes the
relationship between real output (GDP) and nominal interest
rates. On a graph with real interest rates on the vertical axis and
real GDP on the horizontal, IS-LM is seen as a downward-
sloping
IS curve (investment and savings, or the market for economic
goods) and an upward-sloping LM curve (liquidity preference
and
money supply). The intersection of these curves indicates an
economy’s equilibrium interest rate and GDP.
10 This is the idea that if people feel poor because the economy
is not prospering, they’ll cut back on spending; that cutback
will, in
turn, encourage businesses to retrench on investment and hiring,

leading to a self-fulfilling prophecy of economic downturn. The
“paradox” is that while thrift at the individual level may be
wise, it
can have a harmful impact on the broader economy and
ultimately
on individuals as well. See, for example, “Paradox” Redux in
the
June 2013 Region.
11 Businesses reducing investment when they experience lower
sales, for instance, or households cutting back because they feel
poor with the fall in house prices.
12 For another model that may also be able to come to terms
with
the data on the Great Recession, see Buera and Nicolini (2016).
References
Bernanke, Ben S. 2005. “The Global Saving Glut and the U.S.
Current Account Deficit.” Sandridge Lecture. Virginia
Association
of Economists, April 14.
Bernanke, Ben S. 2010. Statement before the Financial Crisis
Inquiry Commission. Washington, D.C., Sept. 2.
https://www.federalreserve.gov/newsevents/testimony/bernanke
20100902a.pdf
Buera, Francisco and Juan Pablo Nicolini. 2016. “Liquidity
Traps
and Monetary Policy: Managing a Credit Crunch.” Unpublished
manuscript, Federal Reserve Bank of Chicago.
Christiano, Lawrence J., Martin S. Eichenbaum and Mathias
Trabandt. 2015. “Understanding the Great Recession.”

American
Economic Journal: Macroeconomics 7 (1): 110-67.
https://minneapolisfed.org/publications/the-region/paradox-
redux
https://www.federalreserve.gov/newsevents/testimony/bernanke
20100902a.pdf
1/22/2018 It Wasn't Household Debt That Caused the Great
Recession - The Atlantic
https://www.theatlantic.com/business/archive/2014/05/house-of-
debt/371282/ 1/10
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Why are nearly 10 million people still out of work today? Was
it because in
September 2008, the U.S. government failed to bail out the
insolvent investment
bank Lehmann Brothers? Was it because the two U.S. housing
finance giants
Fannie Mae and Freddie Mac guaranteed too many mortgages
securitized by
It Wasn't Household Debt That Caused the Great
Recession

It was how that debt was disproportionately distributed to
America’s most
economically fragile communities.
HEATHER BOUSHEY
MAY 21, 2014 | BUSINESS
Reuters
http://www.theatlantic.com/newsletters/daily/
https://www.theatlantic.com/author/heather-boushey/
https://www.theatlantic.com/business/
debt/371282/ 2/10
Lehman and other Wall Street firms to low-income borrowers in
the run up to the
housing and financial crises? Or does blame rest with the
Federal Reserve’s too-
easy-money policies in the wake of the brief dotcom recession
in the early 2000s?
Princeton University professor Atif Mian and University of
Chicago Booth School of
Business professor Amir Sufi pin the blame squarely on
policymakers, but not for

any of these three reasons, all of which are variously popular
with policymakers on
different sides of the political divide in Washington. Instead, in
their just-released
book, House of Debt, they argue that the Great Recession was
the result of a sharp
fall-off in consumption due to the unevenly accumulated
household debt in the first
six years of the 21st century. In that period, mortgage-credit
grew more than twice
as fast in neighborhoods with low credit scores than in
neighborhoods with high
credit scores, a marked departure from the experience of
previous decades. When
the housing bubble popped, the economic consequences were
sharply magnified by
the way debt was distributed across households and
communities.
How did this happen? Why did lenders suddenly shower less-
creditworthy
borrowers with trillions of dollars of credit? Mian and Sufi
demonstrate this was
enabled by the securitization of home mortgages by investment
banks that did not

seek federal guarantees from Fannie and Freddie—so called
private-label
securities, made possible by financial deregulation and the glut
of cash in world
markets in the wake of the Asian financial crisis of the late
1990s. That private-
label mortgage-backed securities were at the core of the housing
meltdown is no
longer in doubt, but what Mian and Sufi bring to the debate is
how an unequal
distribution of debt magnified the economic risks—based on
their path-breaking
microeconomic research—and a new framework for considering
who is to blame
among policymakers for the still reverberating debacle.
Unfortunately, the two authors don’t provide answers for why
so many households
took on so much debt, but they do paint a cautionary tale. This
is a critically
important contribution to the policy debate now raging over
what Congress and the
Obama administration should do in the way of reforms to the
housing-finance
industry. And, it’s important to our understanding of whether

and how inequality
http://www.amazon.com/House-Debt-Recession-Prevent-
Happening/dp/022608194X
debt/371282/ 3/10
affects economic growth and stability. What they demonstrate is
that as the U.S.
housing bubble burst and home prices began to fall in late 2006,
the unequal
distribution of debt amplified the decline in consumer spending
and the
consequence was an economic disaster. Mian and Sufi’s
research leads them to
conclude that the crisis was avoidable if only economists had
used the right
framework to see what was happening around them at the time.
“Economic disasters are man-made,” they write in the opening
pages, “and the
right framework can help us understand how to prevent them.”
By the end of the
book, the reader cannot but be left appalled at the sheer

enormity of the policy
failures. It’s not just that 7.4 million workers lost their job
during the years of the
Great Recession of 2007-2009 but also that the employment
crisis continues to
this day. While jobs are no longer being shed at the rate of
20,000 a day, the share
of the U.S. population with a job fell to a low of 58.2 percent in
November 2010
from a high of 63.4 percent in December 2006, but has only
increased by a fraction
of a percentage since then, hitting just 58.9 percent in April
2014.
Missing the housing bubble was a massive failure on the part of
policymakers. As a
result, our new normal is one where there are nearly 10 million
fewer people at
work. This book's contribution helps us understand the
important mechanisms
through which this occurred.
* * *
I watched the housing and financial crises unfold from my perch
as staff for the U.S.

Congressional Joint Economic Committee. By the time Lehman
Brothers failed, the
mantra on Capitol Hill had been articulated by former Treasury
Secretary Lawrence Summers, who said that any recovery
package had to be
“timely, targeted, and temporary.” But the stimulus that
emerged was not
specifically targeted at homeowners in foreclosure. If Mian and
Sufi are correct, the
biggest failure was—and continues to be—leaving families
struggling with
mortgages they cannot afford because of the fall in home prices.
http://www.nytimes.com/roomfordebate/2014/05/20/did-the-
bank-bailout-do-enough-for-the-country
debt/371282/ 4/10
The federal government has provided assistance to a paltry
940,000 struggling
homeowners through the Homeowners Assistance Mortgage
Program, in a nation
where 5 million homes have been foreclosed on. This lack of

help hasn’t just hurt
those homeowners. Also caught in the downdraft are now
destroyed
neighborhoods, ruined communities, and thwarted lives of far
too many.
Protecting banks does not necessarily make the economy strong.
So, how did we get here? That’s the focus of House of Debt.
Mian and Sufi spent the
past decade compiling and analyzing microeconomic data to test
theories about
how the macroeconomy works. They conclude that inequality in
wealth and debt
combined with greater availability of credit to marginal
borrowers are a toxic
macro-economic combination. They call this the “levered
losses” view, arguing
that severe recessions occur when “asset prices collapse and
households sharply
pull back on spending,” even with “no obvious destruction of
productive capacity
occurs."
Their story starts with an accumulation of debt—lots of it. After
the Asian financial

crisis in 1997, investors were looking for safe havens to park
their money. What
they wanted were AAA-rated bonds. What they got were
mortgage-backed
securities that were rated AAA but turned out to be junk. As we
all now know—but
most of us didn’t know at the time—Wall Street firms in the
early 2000s began
slicing and dicing and then reassembling mortgage debt into
more and more exotic
and risky mortgage-backed securities in ways that made them
look risk-free.
If debt had been more equally distributed then the decline
in consumption would have been less dramatic and the
recession would have been less devastating.
But, it wasn’t just that there was more securitization. It was that
loans made to
riskier borrowers were more likely to be securitized. This both
drove the housing
bubble and made the consequences of it popping all the worse.
Mian and Sufi point
out that between 2002 and 2005, the growth in mortgage credit
and household

debt/371282/ 5/10
incomes became negatively correlated, that is, credit expanded
in areas where
incomes were declining. This makes no sense: How can you pay
back a loan if your
income is falling? They point to academic research by Yuliya
Demyanyk and Otto
Van Hemert showing the profound consequences: By 2006,
loans had become so
disconnected from prudent business practices that “an unusually
large fraction of
subprime mortgages originated in 2006 and 2007 [became]
delinquent or in
foreclosure only months later.”
As these foreclosures began to pile up, affected households cut
back sharply on
spending. Thus, the catalyst for Great Recession had begun two
years before the
dramatic demise of Lehman Brothers. In the second quarter of
2006, the collapse
in consumption started with residential investment, which fell

by a 17 percent
annual rate. Non-residential investment didn’t begin to fall until
late in 2008, but
by then households had already pared back spending sharply.
This fallout from the collapse of the housing bubble was
amplified by the unequal
distribution of net wealth. What Mian and Sufi find is that
counties with the largest
decline in total net worth—were the ones that cut back most on
spending when
house prices declined. As housing prices began falling in 2006,
in counties where
net worth had declined most, consumption fell by almost 20
percent, compared to
only five percent for the entire U.S. economy. In contrast, even
through 2008,
counties that avoided the collapse in net worth saw almost no
decline in spending.
If debt had been more equally distributed then the decline in
consumption would
have been less dramatic and the recession would have been less
devastating.
Mian and Sufi are part of a new generation of economists
who examine detailed microeconomic data to understand

the macroeconomy, giving us a deeper understanding of
how inequality affects growth and stability.
Further, they point out that you cannot have a foreclosure
crisis—or its associated
sharp fall-off in demand—without debt and the way that debt
grew during the early
2000s exacerbated the potential for a foreclosure crisis. Mian
and Sufi find that
debt/371282/ 6/10
about half of the rise in mortgage debt was among people who
lived in their homes,
not new purchasers. People took out home equity lines of credit
and used the cash
for home improvements, funds for their kids' college tuition, or
other types of
consumption. Once the crisis was in motion, about four-in-10
mortgage defaults
were among home-equity borrowers. Thus, the foreclosure crisis
was not due to
people reaching to buy homes, but to borrowing against their

primary asset. Had
they not ramped up borrowing, falling home prices would not
have affected
consumption or led to record-high foreclosures.
Finally, all this subprime mortgage debt that had been
structured into AAA-rated
mortgage-backed securities created financial instruments in
which no single
investor has the incentive or legal right to restructure the loan,
especially for loans
to low-net-worth borrowers. This led to a situation that
dramatically reduced the
capacity of homeowners to get relief in form or informal
backruptcy and increased
foreclosures. Foreclosures reduce prices more so than principal
reductions and thus
amplified the decline in home prices and the loss in wealth.
* * *
Given the troubling rise in economic inequality over the past
four decades, this
research could not be more timely. It’s not just the questions
they are asking and
the results they are finding, but also the methods they are using.

Mian and Sufi are
part of a new generation of economists who examine detailed
microeconomic data
and analysis to understand the macroeconomy, giving us a
deeper understanding
of how inequality affects economic growth and stability. They
have done this by
using detailed, microeconomic data at the county and zip-code
level to examine
debt and consumption patterns.
Mian and Sufi’s research shows that the marginal propensity to
consume—an
economics term that describes the amount of spending done
after receiving an
additional dollar—out of housing wealth depends not just on the
value of the asset
but also the debt burden, settling a near-century-old economic
debate between two
of the most prominent economists of the 20th century.

debt/371282/ 7/10
In The General Theory of Employment, Interests, and Money,
University of Cambridge
economist John Maynard Keynes argued in 1936 that the
distribution of income
mattered for the stability of the macroeconomy. Increased
spending, be it from
consumers, government, greater exports, or investment, will
multiply as it works its
way through the economy. If additional income goes into the
hands of those with a
high marginal propensity to consume then the multiplier for
consumption demand
will be relatively larger. But if additional income goes into the
hands of those with a
lower marginal propensity to consume then the multiplier on
consumption demand
will be relatively weaker.
Two decades later, University of Chicago economist Milton
Friedman
hypothesized that although rich households appear to consume
less, they have a
pretty clear sense of what their standard of living will be on
average year after year

and they adjust their savings to keep themselves at that level. In
good years, when
they get an income bonus, they will save a more while in bad
years, they won’t save
as much—or will borrow—to maintain that average standard of
living.
Yet neither Keynes nor Friedman had access to the kinds of data
now at the
fingertips of Mian and Sufi. Thus the Keynes-Friedman debate
was theoretical, not
grounded in empirical reality. Now, Mian and Sufi provide a
definite “yes” to the
question of whether we could have prevented the Great
Recession—and the
conclusion isn’t pretty. They argue that policymakers could
have seriously
mitigated the damage, pointing out that debt forgiveness would
have been much
more effective that the policies implemented because it would
have targeted
households with the largest marginal propensity to consume.
This is a failure on a
massive scale and more economists need to follow the lead of
Mian and Sufi and

look deep into the data to understand what we got wrong.
Mian and Sufi’s argument hinges on the conclusion that it was
the supply of credit
that drove the bubble and the heightened debt burdens, rather
than increased
demand from consumers. They discuss some reasons why people
may have wanted
to borrow more, such as the idea that people who expected
higher incomes were
borrowing constrained, but come down on the side that people
were just acting
debt/371282/ 8/10
irrationally—given that the massive increase in borrows during
the credit boom was
among borrowers with declining incomes, not those with rising
incomes. From this,
they conclude that “whatever the reason, however, consumers
who were offered
more money by lenders took it.”

Were people behaving irrationally? And, what (really) does that
mean? The late
1990s saw the strongest labor market in decades. The typical
male earner saw his
annual earnings finally grow, after over a decade-and-a-half of
inflation-adjusted
declines; women’s employment rates hit an all-time high of 58
percent; and the
typical family income grew by an average annual rate of just
under 2 percent. The
middle was (finally) back, so it may have been the case that
people were optimistic
that the recession of 2001 would not just be short and shallow,
but that the
recovery would look like the late 1990s.
But looking closely at the data reveals another pattern. One
thing that did not
happen during the recession of the early 2000s was a rise in
government
borrowing. The cash seeking a safe haven from the Asian
financial crisis had to go
somewhere, but the federal government wasn’t in the mood to
borrow. So those

dollars flowed willingly into the mortgage-backed securities
being peddled as AAA-
rated bonds. And the greater the demand, the more Wall Street
packaged up their
dodgy securities containing more and more subprime loans
extended to those least
able to afford credit.
The last few decades of the 2oth century also saw a number of
marked changes for
families. Women increased their labor supply steadily from the
1960s through the
high employment years of the early 1990s. By the late 1990s,
however, that long-
term rise in employment rates had stalled. The United States
went from being an
economy that had one of the largest shares of women in the
labor force to number
18 among 35 developed-economy member nations of the
Organisation for
Economic Co-operation and Development.
A variety of reasons have been presented for the sudden end in
the growth of
women’s employment beginning in the first decade of the 21st
century and

continuing today. The mainstream media play up the idea that
women are “opting
debt/371282/ 9/10
out” of careers in favor of motherhood, a story line developed
in large part by
journalists who either live in more wealthy neighborhoods and
thus see this
happening or write for publications that cater mostly to these
wealthy
neighborhoods. Yet empirical research finds that women, like
men, found it harder
to find and keep jobs due to the lackluster economic recovery
after the recession of
2001. As families sought to cope with the slow-job growth
economy in the 2000s
and a labor market that still does not provide the kinds of
supports and protections
working parents need, many turned to increasingly-readily-
available credit as a way

to cope.
Now, of course, such easy credit is no longer available. Neither
is a robust jobs
market. It may be true that it doesn’t matter why people took on
more debt prior to
the Great Recession, as Mian and Sufi contend, but today the
lessons learned then
are critically important. The story that emerged in the early
days of the Great
Recession was that too many people borrowed too much to
afford fancy houses.
That’s not what Mian and Sufi’s data show. They show that the
boom in debt
occurred among borrowers that couldn’t qualify for a
government-backed
mortgage. That the private sector sought them out in the tens of
millions to offer
loans they were demonstrably unable to repay—without worry
because these
lenders very quickly diced up those loans and sold them to
supposedly savvy
institutional investors—created the housing bubble that
exploded into the twin
crises that led to the Great Recession.

This activity produced a bubble—one that anyone could see and
one that
policymakers blithely passed off as either non-existent or
unimportant—to the
detriment of our entire economy. Subsequent reforms to our
financial system give
policymakers more tools to police housing finance, yet the
continuing over-reliance
on debt and a lack of good jobs leaves families at risk and
exposes our economy to
the whipsaw of another debt-fueled credit bubble. Mian and Sufi
deserve credit of
another kind for detailing how ensnared the American Dream is
in this tangled web
of debt finance—and how exposed the vast majority of us are to
the broader
economic consequences.
ABOUT THE AUTHOR
debt/371282/ 10/10

HEATHER BOUSHEY is the executive director and chief
economist at the Washington Center
for Equitable Growth.
https://www.theatlantic.com/author/heather-boushey/
http://equitablegrowth.org/
The topic will be Secular Stagnation. Details below:
Topic: Did the “Great Recession” Lead to Secular Stagnation
and How Should Policy Respond?
Your assignment is to write an essay that analyzes the debate
about secular stagnation in the aftermath of the Great Recession
and to recommend policies in a way that is consistent with your
diagnosis of the current situation. A complete assessment of the
secular stagnation debate requires an understanding of how the
economy got into this situation. Therefore, your essay should
discuss the sources of the Great Recession and explain why
some economists argue that the crisis led to secular stagnation.
Your analysis should cover different sides of the debate, but it
should lead to a clear statement of your own view about how the
stagnation concept does or does not apply to the current state of
U.S. economy. Based on this opinion, discuss the best path
forward for economic policy.
You need to consider the following concepts and questions:
· What was the source of the Great Recession and how did it
lead to the possibility of secular stagnation?
· Link your analysis of what has happened with the Classical
and Keynesian macroeconomic perspectives. Discuss how
aspects of these theories are (or are not) helpful in explaining
the relevant history. Also, your grade will be better if you can
build a somewhat nuanced story that demonstrates a deep
understanding of the theories.
· When discussing secular stagnation directly, I encourage you
to consider ways in which the recent recovery has been different
from what happened after earlier recessions.

· Link your policy recommendations in a consistent way to your
theoretical and empirical understanding of the secular
stagnation debate. Consider how both fiscal and monetary
policy could improve the U.S. economy over the next few years.
You should use the readings below to help guide your thinking
about the essay. You may use outside resources, but it is not
necessary to do outside research that goes beyond the readings.
The target length of the essay is 2,500 words (approximately 5
pages single spaced). Please use 12 point, Times New Roman
font.

Secular StagnationWhy Might Equilibriu.docx

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