Page 88 - Accelerating out of the Great Recession

THE NEW REALITIES

ity for business managers. Answering the question correctly
could offer huge opportunities.
We think that the jury is still out on what might happen. Let
us quickly summarize why we think both options are possible.
In Chapter 1, we discussed the need of private households,
corporations, and financial institutions to pay back their debt—
to deleverage. This pressure is amplified by the drop in asset
values, mainly stocks and real estate, which intensifies the pres-
sure on debtors to make repayments. The devastating power of
such deleveraging was described by Irving Fisher in “The Debt-
Deflation Theory of Great Depressions” (see the sidebar at the
end of this chapter).
The goal of the massive government and central bank inter-
vention in the major economies of the West has been to avoid
a repetition of such a debt-deflation spiral. It would have had
extremely grave implications for the economy, employment,
and social stability. In late 2008, the Bank of England’s
Monetary Policy Committee saw that the “risks to inflation
9
have shifted decisively to the downside.” The IMF was simi-
larly pessimistic at that time, stating that “another downside
risk [to the already negative scenario of lower worldwide
growth] relates to growing risks for deflationary conditions in
advanced economies.” 10
It is true that deflation must be avoided because it would
increase the current debt burden. It would also, by triggering
alarm about falling prices, lead to a reduction in consumer
demand. The lessons from Japan during its Lost Decade in
the 1990s (and beyond) should be a warning to policymakers
today: notwithstanding major public spending, zero interest
rates, an undervalued yen, and a fast-growing world economy,
Japan did not escape recession and continuing deflation.

■ 67 ■