Financial crises create long periods of slow growth, for which increased spending isn't the solution

See Stimulus Optimists vs. Economic Reality, by Kevin Hassett, WSJ, 8-3-11. Mr. Hassett is director of economic policy studies at the American Enterprise Institute.

"Consider the problem of economic stabilization. In the old days, U.S. recessions were short and recoveries sharp: Between World War II and 1990, the average rate of growth in gross domestic product (GDP) in the five quarters after a recession was 6.8%.

Obama administration officials should have known all this as they set out in 2009. Financial crises inevitably create lengthy periods of slow economic growth, as research by economists Carmen Reinhart and Kenneth Rogoff has shown. The typical duration of the employment downturn after a financial crisis is 4.8 years. Another study by Ms. Reinhart and her husband Vincent Reinhart found that economic growth rates tend to be lower for as much as a decade after financial crises.

Given this lengthy period of slow growth, it was a mistake for the Obama administration to pursue short-term Keynesian stimulus. Such a policy might be wise if the economy were in a typical recession, which can be expected to last a bit less than a year and be followed by a recovery with sharply higher growth. In such a case, adding a percent or two of growth during the recession might be worth having a slower recovery.

But in the lengthy, slow‐slog out of a financial crisis, the stimulus hangover arrives before the recovery has taken off. Temporary stimulus therefore hurts the economy when it is removed and again when it is paid for. The hangover is virtually guaranteed to arrive at a moment when it can push us back into recession.

Worse, aggressive stimulus sets off a kind of Keynesian death spiral in which nervous politicians adopt repeated stimulus packages in order to avert near-term distress, the cumulative effect of which can be ruinous.

Keynesians might dispute this logic, saying that their policy prescription helps avert "catastrophic panic" in the economy. But there is no established connection between higher government spending and the mental health of consumers and investors, and there likely never will be."