Recessions are always and everywhere a monetary (medium of exchange) phenomenon. Recessions are an excess demand for money (the medium of exchange). The demand for money is the demand for an asset. Since the demand for money, like the demand for all assets, depends very much on expectations, especially when interest rates are low, recessions depend very much on expectations too, especially when interest rates are low.Read it at Worthwhile Canadian Initiative
How much do expectations matter?
by Nick Rowe | Associate Professor, Carleton University
Warren Mosler: "All recessions are balance sheet recessions."
NR: "Recessions are an excess demand for money (the medium of exchange)." Another way of stating this is that recessions are due to a preference for liquidity that results in increased propensity to save.
The question is why this preference and this shift in propensity.
The debate between monetarists and fiscalists hinges on how to address the preference for liquidity. Monetarists say alter expectations by creating inflationary expectation that increase the cost of holding money, thereby reducing the propensity to save and increasing the propensity to invest and consume.
Fiscalists criticize this on two major counts, holding that monetarists are ignoring the why of liquidity preference, hence treating the symptom rather than the cause.
First, fiscalists assert that if the recession is due to the necessity to reduce borrowing, to deleverage, and to rebuild equity, then if monetary policy actually would work, it would just exacerbate the situation by increasing private debt, setting the stage for another perhaps deeper recession due to debt-deflationary effects. This is indeed what happened with multiple bubble blowing by increasing private indebtedness, especially coupled with large and persistent trade deficits.
Secondly, fiscalists add that when a recession is due to above ordinary accumulation of private debt, so that deleveraging is forced upon many people and the contraction of the real economy is so deep as to create above normal unemployment, then unless the sum of net exports plus the government fiscal deficits is large enough to offset the demand leakage to increased domestic private saving, the economy will not recovery until balance sheets are sufficiently restored to warrant more private credit expansion.
In this case, the result will be a stagnant recovery, and if monetary policy is too loose, it will exacerbate the situation by leading to asset appreciation, and with commodities now considered an asset class by money managers, this will lead to a rise in consumer prices. If one of these assets happens to be vital, like petroleum, then the effect of rising prices will spread through the economy resulting it consumers being squeezed by the need to pay down debt and pay higher prices for necessary goods, like food and fuel. The result of this will be stagflation.
So far, monetary policy has failed to create the expectations necessary in spite of massive departure of the Fed from normal policy. The latest suggestion from market monetarists is NGDP targeting. Not only are fiscalists skeptical but David Andolflatto is, too, even though he is willing to consider it.