, Columnist
We're Still Not Sure What Causes Big Recessions
Is the trigger too much debt or when people start feeling poorer?
How did it come to this?
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There is an important, but quiet debate in the economics profession about what leads to big recessions: wealth or debt.
Almost everyone agrees, at this point, that the Great Recession of 2007-09 was caused by the financial system. But that leaves the question of what, exactly, happens in a financial system that leads an economy to crash. Formal economic models of financial shocks are not very realistic. They usually assume the harm comes from disruption to the banking system, which acts like a supply bottleneck that chokes off economic activity. But the Great Recession and similar episodes look very much like demand shocks, with low inflation and lots of spare capacity.