The Recession in the U.S. and Europe That Never Truly Ended

Why does it still feel like a recession? Economist Richard Koo has a simple explanation (pdf, via Krugman): We're still in a recession.

This kind of recession Koo is talking about is not a technical recession. After all, the economy is technically growing -- slowly, imperceptibly, like the turning of the earth. But upon closer inspection, we're in a shadow recession he and other economists call a "balance sheet recession." That means that just about everybody in the Western World -- households, corporations, and sometimes even governments -- is focused on paying off our balance sheets (i.e.: paying off debt) at the same time. That's nice for our balance sheets. But it's a horrible way to jumpstart a weak economy.

Koo does the yeoman's work of drawing the picture of balance sheets in the United States and some major European economies. The jagged lines are a bit of an eyesore, but they tell a simple story. Between the IT Bubble and the Housing Bubble that book-ended the 2000s, households (in red), corporations (in blue) or both borrowed lots of money, year after year. Then the recession hit, and our incomes fell, and we started running surpluses by saving more of our money.

First up: The United States. In the years after the tech bubble, the U.S. economy relied on Americans buying more houses -- and more expensive houses -- than ever before. Today, Americans are buying the fewest number of homes in 60 years, a fifth of homeowners are underwater, and savings rates have shot up. Deleveraging created a whopping 9-percent-of-GDP shift toward savings in the private sector. Meanwhile, the public sector's borrowings offset only about two-thirds of that shift.

It's the same song in Great Britain. Households borrowed their way through the 2000s. Recession hit in 2008, and the private sector swung massively toward savings more than the government swung toward borrowing.

In Spain and Ireland, the shift has been even more staggering, but the upshot is the same: private sector deleveraging reached about a fifth of GDP in both countries.

What's happening around the world is that the housing bubble has popped, residential investment has cratered, households are savings billions of dollars they would have been spending just five years ago, and governments have run deep deficits as a result of (1) much lower tax revenue and (2) higher mandatory and stimulus spending.

The conservative explanation of the way out of the balance-sheet recession, as I understand it, is that with Obama gone, we can set aside the regulations that are keeping business investment on the sidelines, lower taxes, cut government, and encourage companies and households to start spending much more of their money. This scenario isn't impossible, but it also strikes me as highly unlikely.

Unemployment, by various measures, is 9% (official), 11% (official, with 2009's participation rate), or 16% (broader "U6" measure). Without government spending, it would probably be higher. Demand is terribly low (Inflation-adjusted income per person is lower today than it was in 2006). Without government assistance, it would probably be lower.

Government borrowing in the graphs above replaces a lack of private sector spending. It is a crutch. If we kick out the crutch out from under the economy, it's possible that this patient will learn to walk very, very quickly. But isn't it more likely that we'll fall back into a recession?