The second "Great Contraction"
Containers are stacked a container terminal in Melbourne on March 3, 2010, as Australia's economy shrugged off the first global contraction since World War II to expand 2.7 percent last year, putting other developed countries in the shade, official figures showed. (Getty Images)
August 2nd, 2011
02:18 PM ET

The second "Great Contraction"

Editor's Note: Kenneth Rogoff is Professor of Economics and Public Policy at Harvard University. He was formerly chief economist at the IMF. He will be on CNN GPS this Sunday at 10am ET/PT. For more from Kenneth Rogoff, visit Project Syndicate and check it out on Facebook and Twitter.

By Kenneth Rogoff, Project Syndicate

Why is everyone still referring to the recent financial crisis as the “Great Recession”? The term, after all, is predicated on a dangerous misdiagnosis of the problems that confront the United States and other countries, leading to bad forecasts and bad policy.

The phrase “Great Recession” creates the impression that the economy is following the contours of a typical recession, only more severe – something like a really bad cold. That is why, throughout this downturn, forecasters and analysts who have tried to make analogies to past post-war U.S. recessions have gotten it so wrong.

Moreover, too many policymakers have relied on the belief that, at the end of the day, this is just a deep recession that can be subdued by a generous helping of conventional policy tools, whether fiscal policy or massive bailouts.

But the real problem is that the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.

A more accurate, if less reassuring, term for the ongoing crisis is the “Second Great Contraction.” Carmen Reinhart and I proposed this moniker in our 2009 book This Time is Different, based on our diagnosis of the crisis as a typical deep financial crisis, not a typical deep recession. The first “Great Contraction” of course, was the Great Depression, as emphasized by Anna Schwarz and the late Milton Friedman. The contraction applies not only to output and employment, as in a normal recession, but to debt and credit, and the deleveraging that typically takes many years to complete.

Why argue about semantics? Well, imagine you have pneumonia, but you think it is only a bad cold. You could easily fail to take the right medicine, and you would certainly expect your life to return to normal much faster than is realistic.

In a conventional recession, the resumption of growth implies a reasonably brisk return to normalcy. The economy not only regains its lost ground, but, within a year, it typically catches up to its rising long-run trend.

The aftermath of a typical deep financial crisis is something completely different. As Reinhart and I demonstrated, it typically takes an economy more than four years just to reach the same per capita income level that it had attained at its pre-crisis peak. So far, across a broad range of macroeconomic variables, including output, employment, debt, housing prices, and even equity, our quantitative benchmarks based on previous deep post-war financial crises have proved far more accurate than conventional recession logic.

Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.

For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries.  For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.

Is there any alternative to years of political gyrations and indecision?

In my December 2008 column, I argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years. Of course, inflation is an unfair and arbitrary transfer of income from savers to debtors. But, at the end of the day, such a transfer is the most direct approach to faster recovery. Eventually, it will take place one way or another, anyway, as Europe is painfully learning.

Some observers regard any suggestion of even modestly elevated inflation as a form of heresy. But Great Contractions, as opposed to recessions, are very infrequent events, occurring perhaps once every 70 or 80 years. These are times when central banks need to spend some of the credibility that they accumulate in normal times.

The big rush to jump on the “Great Recession” bandwagon happened because most analysts and policymakers simply had the wrong framework in mind. Unfortunately, by now it is far too clear how wrong they were.

Acknowledging that we have been using the wrong framework is the first step toward finding a solution. History suggests that recessions are often renamed when the smoke clears. Perhaps today the smoke will clear a bit faster if we dump the “Great Recession” label immediately and replace it with something more apt, like “Great Contraction.” It is too late to undo the bad forecasts and mistaken policies that have marked the aftermath of the financial crisis, but it is not too late to do better.

The views expressed in this article are solely those of Kenneth Rogoff. Copyright: Project Syndicate, 2011.

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Topics: Debt Crisis • Economy • United States

soundoff (17 Responses)
  1. John Murphy

    Excellent insight and analysis Professor Rogoff. Thank you.

    August 2, 2011 at 2:26 pm | Reply
  2. Mr. A.M. Velez

    Mr. Zakaria,
    We need more people like you to do research, thanks for your insights. As the country continue to discuss the reasons for our country's downward movement, would you discuss why so much money is moving to gold investments when this country needs the money in the companies/corporations that are creating jobs? I understand the investment security issue, but if our companies fail, what are we eating...Gold? Another issue, that is as important as water, is gasoline prices...does USA have enough power to control gas prices or leadership is so weak that OPEC is allow to do what they want? How can anyone make long term plans with gas prices changing daily. Thanks for all you do,

    August 2, 2011 at 3:23 pm | Reply
    • Michael Balme

      Mr. Velez,
      Just to let you know, commodity price volatility is one reason for the creation of futures and options markets. Using these "derivatives" one can lock in the price of a commodity months in advance.

      August 11, 2011 at 9:43 pm | Reply
  3. j. von hettlingen

    "In my December 2008 column, I argued that the only practical way to shorten the coming period of painful deleveraging and slow growth would be a sustained burst of moderate inflation, say, 4-6% for several years."
    If you think that this approach would help the economy recover faster, how are you going to trigger an inflation? By printing more greenbacks?

    August 2, 2011 at 5:28 pm | Reply
    • Craig

      That's precisely what the December 2008 article calls for, the printing of more money.

      August 9, 2011 at 10:39 pm | Reply
  4. david k lashley


    In 2010, we imported $3,649,439,000,000.00 worth of products from China.
    In 2010, we imported $229,907,900,000.00 worth of product from Mexico.

    For the ease of calculation, lets say all products from China and Mexico had a cost of 50% material, 20 % labor, 30% profit.

    So if we multiply 20% times $4,379,887,800,000.00 we get $875,863,560,000.00

    The average assembly worker in the U.S. is from $50,000.00 to $75,000.00.

    If these products were manufactured in the U.S. then
    $875,863,560,000.00 divided by $50,000.00 equals 17,517,271 jobs
    $875,863,560,000.00 divided by $75,000.00 equals 11,678,180 jobs

    August 2, 2011 at 7:22 pm | Reply
    • Fred E

      Are you serious David? Do you think they pay their average worker $50000 in China or Mexico? Probably not. Basically what you're saying is bring those production jobs to America for 10 or 20 times the cost it takes to make those products abroad? WHY? You can bring those jobs "back" to America as long as you don't mind spending $500 for a pair of shoes, $250 for a Gap Sweater, or $5000 for a TV, but unfortunately no one will pay those prices. America is caught in a very scary position and it is unfortunate.

      August 15, 2012 at 11:30 am | Reply
  5. bruno

    Did ya notice how the debt issue got resolved right before Washington's Summer Vacation!!
    Those sly think they got some people in such a

    August 2, 2011 at 7:56 pm | Reply
  6. fernace

    The biggest problem we've had in the past few weeks is not whether to call it a recession, depression or contraction, as Professor Rogoff suggests, but to get some co-operation from the teabag people! The 1st battle is finally over & we can heave a sigh of relief. But don't get too comfortable, there is still work to do with the budget & the teabags will behave as they did this time, holding us "hostage" 'til they get what they want! It seems to me they are actually a party unto themselves, who would not be in congress & have this platform if they hadn't piggy backed on the Reublicans! They are a party with their own goals & agendas, but going through proper methods to be heard takes too long, so they are leaching off an established political party with similar ideas! The problem is many of the Republican citizens are appalled by their tactics & don't agree with their agenda! They need to be investigated!!

    August 2, 2011 at 8:39 pm | Reply
  7. someguyz

    Why does it matter what we call it? Just fix the thing already. You can play with your words all you like but there are actual people needing help right now

    August 3, 2011 at 11:37 am | Reply
  8. atie

    Wasn't this the professor who held views on Iceland which were altered at a later stage as shown in Inside Job.
    Go abroad and see that America is much more down the drain than other countries, so stop comparing.
    You need to raise taxes and alongside with education improvement and the will power of Americans it will become better.
    Otherwise you will have to try and find a job elsewhere as immigrants, including the professor, because you need to generate your own income and pay taxes on it. Example: Austria, fine country, hardworking and pleasant people.

    August 3, 2011 at 2:08 pm | Reply
  9. GOPisGreedOverPeople

    It really is.

    August 4, 2011 at 9:44 am | Reply
  10. Judy

    I think the investors,money people,CEOS,Wall Street,Banks,the millionaires and billionaires are all cowards! This is when these people should invest in the USA and start manufacturing again! The job market is ripe for employers, the country is hungry for products made in the USA and just think what good publicity for the company or corporation or bank that actually put the country first before profits!! Cowards all!!

    August 4, 2011 at 6:46 pm | Reply
    • Fred E

      Judy, seriously. There is a reason why they make millions and you don't. You can't bring manufacturing jobs back to America in a Global economy. Who is going to buy these goods? You? Come on now. Manufacturing the way it WAS in America is dead. Forget our generation, we're screwed, but we can help tomorrows kids by educating them now. In a Global economy a High School diploma is as good as toilet paper, so is an honours degree -in fact, you'll probably need a masters or Ph D to compete in tomorrows world. The H1B Genius visa allows students from abroad to study at prestigious Universities in the USA, they pay double or triple what an American would pay for that same education. Then they leave and start entire industries in developing notice I said industry and not a company. They create entire INDUSTRIES! The USA is in a tight spot and I fear where this all leads because Americas biggest asset's Army. HooRaaa

      August 15, 2012 at 11:39 am | Reply
  11. really?

    Really? You have to play games with semantics instead of admit an error?

    August 9, 2011 at 9:40 pm | Reply

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