We agree with the view that this is the greatest global financial crisis since the Great Depression. The global economy was in freefall in the fourth quarter of 2008 and this should continue in the early months of 2009. This has created fears of a global depression. However, we expect a severe global recession rather than a depression. The key to our view is that policymakers have a correct diagnosis of the severity of the financial crisis and should continue to be proactive in responding aggressively to it. This contrasts with the experience of the 1930s and the Japanese stagnation after the Nikkei bubble.

However, even after the recession is over, we do not expect a strong economic rebound in the early quarters of recovery. Such a strong initial rebound has occurred in past business cycles dominated by inventory cycles rather than by serious systemic financial crises. Instead, we expect a subpar recovery in the initial phase of this economic cycle. The financial system is on a path of gradual recuperation and much of the credit available will be utilized to refinance existing debt rather than finance new spending. This is not just an issue of the supply of credit. The demand for borrowing for new spending (as opposed to refinancing) is also likely to be weak. The major erosion in consumer net worth should limit the demand for new consumer debt. In the corporate sector, excess capacity should tend to restrain capital spending.