It is important not to attribute everything bad that is happening in the economy to the current financial crisis. The economy is going into a recession due to the collapse of the housing bubble. Consumers are cutting back on their consumption because they have seen $5 trillion in housing equity disappear, with another $3 trillion likely to be gone within a year. (The $8 trillion total comes to $110,000 for every homeowner.) This effect is compounded by the tight credit conditions due to the financial crisis, but there has been a tendency in the media to attribute all the bad news in the economy to the financial crisis, as is the case with this front page article in the Washington Post. Firms will always cut back expansion plans during a downturn, even if credit is readily available. Of course, credit will be less readily available for many firms in a downturn, even when the financial system is operating normally. The reason is that weak firms become much worse credit risk in a downturn. We can reasonably hope that the worst of the financial crisis will be over fairly soon (no guarantees). However, even after this crisis passes, we are still likely to be feeling the effects of a serious recession. [Adam Davidson did a much better job on this issue on Morning Edition today.]
--Dean Baker
