Larry Summers is fond of saying:
The central irony of financial crisis is that while it is caused by too much confidence, borrowing and lending, and spending, it is only resolved by increases in confidence, borrowing and lending, and spending. Unless and until this is done other policies, no matter how apparently appealing or effective in normal times, will be futile at best...
I understand what he is saying, but I can't help but think that there has to be a less paradoxical-sounding--and more persuasive--way of putting it.
I agree that a financial crisis depresses an economy by creating deficient supply of some class of financial asset that is then is mirrored by deficient demand for currently-produced goods and services. And I agree that if you fix financial-market excess demand for the right kinds of assets--fix confidence, borrowing, and lending--then you fix the problem.
But you don't fix the problem by simply redoing what you did during the bubble. We are in this mess because during the bubble everybody believed that financial alchemy was creating high-quality savings vehicles--and it wasn't. The task post-crisis is to actually create the high-quality savings vehicles people though they had before the crash--not to spray-paint lead bars with gold, but to use a real philosopher's stone to create real gold bars themselves.
And that is a complex and somewhat delicate task...
