Balance Sheet Recessions

Mark Thoma writes that we need to get better at responding to balance sheet recessions:

When a balance sheet recession hits, one of the keys to a quick recovery is to use the federal government’s balance sheet as a means of offsetting the deterioration in the private sector’s financial position. But we shouldn’t just focus on banks. Household balance sheet problems are every bit as severe, and in total every bit as systemically important as the balance sheet problems of banks. We’ll recover faster from balance sheet recessions if we pay attention to all private sector balance sheets instead of focusing mainly on the problems of banks.

The perception that the government bailed out undeserving wealthy bankers while leaving households to fend for themselves is a big part of the backlash against the policies put into place to help with the recession. That perception is correct, for the most part, and it will stand in the way of repeating this policy the next time there is a financial collapse. When the next balance sheet recession hits, and another one will hit no matter how hard we try to avoid it, we need to do a better job of helping households. Not only is this good economics – we will recover faster with this policy – the politics of helping households are far superior to those associated with bailing out banks.

I agree with the conclusion, but I actually disagree with this analysis. Imagine a recession that begins at a time when nominal interest rates are 9 percent. What’s the right response? Cut nominal interest rates to lower real interest rates and spur growth! Everyone knows that. And this analysis holds true whether or not you think it’s a balance sheet recession, since lower real interests rates are in fact a way of helping households. So if you enter the recession with high nominal rates, the prescription is the same whether or not it’s a “balance sheet recession.” Of course we entered the current recession at a time when pre-recession nominal interest rates weren’t high. That meant nominal interest rates went to zero while still leaving real interest rates higher than they should be. What to do about this has proven to be controversial. But that—the existence of controversy over how to handle the low nominal interest rate situation—is what’s different about this recession.

Now to agree with Thoma’s conclusion, I think the best thing we could do is helicopter drops of money onto households. But that’s not because of special features of a balance sheet recession, it strikes me as in general the best way to respond when the “conventional” monetary toolkit is out of tools.