Last time we had a severe AD shock it was easy to misdiagnose the problem. It coincided with a severe banking panic. Although I believe that the subsequent recession was caused much more by falling NGDP, than banking problems, I can understand how others might have reached different conclusions.
This time there are no excuses. No one in their right mind thinks the stocks of US manufacturing corporations with no loans to Greece or Spain are plunging because of debt problems in Europe. Stocks crashed 4% today because people are increasingly worried about the macroeconomy. Yes, there are real aspects to the Greek crisis. Greece will need to engage in austerity over the next few weeks. But Greece, Portugal, and Spain are not big enough countries to knock 25% off the price of oil in one month. Oil prices are plunging for the same reason as US equity prices are plummeting—fear of a sharp fall in AD (and hence economic activity) all over the world.
Problems in Greece don’t cause 5-year US inflation expectations to suddenly plummet from over 2% to 1.6% in just a few weeks. Falling AD does.
Just as in 2008, the monetary policy screw-up was triggered by a combination of a real shock (banking then, Greece now) and a dysfunctional monetary regime (interest rate targeting.) In 2008 a reasonable person could have attributed all the damage to the real shock. They would have been wrong in my view, but it was a plausible argument. Now there are no more excuses. Money is too tight. The falling asset prices are not directly caused by Greece, that country is much too small. The asset price declines are caused by monetary policy errors triggered by central banks that remained passive in the face of a debt crisis in Europe.
In 2008 people pointed to rapid growth in M2. I don’t think the monetary aggregates are reliable indicators; but even if they were, M2 has actually fallen thus far in 2010.
I don’t doubt there are other explanations. Maybe US stock investors suddenly realized that a new round of “recalculation” was necessary. But why would this need for extra recalculation in America have been triggered by problems in Greece?
In 2008 there were no bloggers pointing to tight money as the problem (although Earl Thompson did publish one article.) Today we have bloggers on the right (me), bloggers in the center (Ryan Avent), and bloggers on the left (Matt Yglesias) all pointing to the need for easier money.
Surely the central banks see the problem—will they have the courage to act?