Evan Soltas
Feb 6, 2013

How a Recession Is Made

Another post in Bloomberg, this one about appreciating the role of expectations and uncertainty in recessions -- and the implications of that role for monetary policy:

Why would such a huge shortfall in nominal GDP unleash economic chaos? The answer gets to the heart of what a demand-driven recession is: a coordination failure. Disruption and dislocation result from what economists call "nominal rigidities." Prices and costs set in nominal terms are "sticky": They don't adjust instantly, and the result is losses, firings and unemployment, canceled investment and debt-service difficulties.


A crucial question, therefore, is how much influence economic policy makers can have over expectations of nominal GDP. Monetary policy, done right, has a lot -- more influence, say, than current-quarter nominal GDP. Even if the Federal Reserve couldn't have avoided the initial crisis, it could have kept the recession shorter and shallower if it had done a better job of anchoring expectations and curbing uncertainty.