Stiglitz: "Any theory of deep downturns has to answer these questions"

From NBER, from the free teaser page that wants $5 for a PDF...

From the abstract (I presume) of Reconstructing Macroeconomic Theory to Manage Economic Policy by Joseph E. Stiglitz (NBER Working Paper No. 20517):

The paper argues that any theory of deep downturns has to answer these questions: What is the source of the disturbances? Why do seemingly small shocks have such large effects? Why do deep downturns last so long? Why is there such persistence, when we have the same human, physical, and natural resources today as we had before the crisis?

Gotcha covered, Joe.

  •   What is the source of the disturbances?

Financial cost.

  •   Why do seemingly small shocks have such large effects?

Debt accumulates slowly, and the cost of accumulated debt grows gradually.

As the rising cost becomes a problem, people compensate by increasing the amount they borrow. So, for a long time, the growing debt seems to have no harmful effects at all. Then one day, a straw breaks the camel's back. When that happens, the full weight of accumulated debt becomes a problem, and large effects follow from the seemingly small shock.

  •   Why do deep downturns last so long? Why is there such persistence, when we have the same human, physical, and natural resources today as we had before the crisis?

We have the same human, physical, and natural resources now as we had before the crisis. We have very nearly the same debt, also. Recommend a policy focused on reducing financial cost by reducing the accumulation of debt, and people will find a million reasons why it cannot and should not be done.

Our deep downturn could have been brought to an end quickly if a conscious effort had been made to reduce debt by a significant amount -- cut in half, say. But since we insist on letting the problem resolve itself, the downturn could last twenty years or more.