by Steven Gjerstad, Vernon Smith
September 16, 2013
Balance sheet crises, in which the prices of widely held and highly leveraged assets collapse, pose distinctive economic challenges. An understanding of their causes and consequences is only recently developing, and there is no agreement at all on effective policy responses. We propose that the Great Depression beginning in 1929 and the Great Recession starting in 2007 were both household-bank balance sheet crises—events that were quite distinguishable from the recessions appearing between them. Each episode, we hypothesize, was preceded by unsustainable rises in expenditures on construction of new housing units and in mortgage credit for purchases of new and existing homes. The Keynesian prescription has been to increase government expenditures and reduce taxes to stimulate growth. But we have described evidence from several countries that the contrary approach has been successful.