In the past I said yes, now I say no. The reason being is that there is something more fundamental going on than household balance sheets being a mess. To see the real problem, consider the standard story told as to why weakened household balance sheets pose such a problem to a robust economic recovery. Here is how Ryan Avent tells it:
In the years prior to the crisis, households accumulated a lot of debt, which was offset by rising asset prices. Those asset prices then collapsed and many households are now desperately attempting to pay down their debts. Because they're heavily indebted, efforts to spark a recovery by encouraging household spending or residential investments are likely to go nowhere; people are simply too broke.
Mark Thoma agrees:
Households have no choice but to set aside part of their income to both rebuild the asset side of the balance sheet and to pay down their debts. This is one of the main reasons why recovery from these “balance sheet recessions” is notoriously slow. As households rebuild their balance sheets, resources are directed away from consumption, and the reduction in aggregate demand is a drag on the economy.
Note that the hindrance to a full recovery in this balance sheet recession story is the increased saving being done to repair the balance sheets. But this begs the question, why aren't the creditors who are receiving the increased payments spending the money? If they were, then aggregate nominal spending would not be disrupted. The problem, then, is not that balance sheets are a mess but that creditors are not providing offsetting spending. Because creditors are holding on to the money payments from debtors, what we fundamentally have is an excess money demand problem. Here is how I explained this problem elsewhere:
[The balance sheet recession view] fails to recognize that for every debtor there must be a creditor. Thus, for every debtor who is cutting back on spending in order to pay off his debts, there is a creditor receiving money payments. In principle, these creditors should be increasing their money spending to offset the decline in money spending by the debtors — but if that were happening, there would have been no decline in overall total current-dollar spending. Instead, creditors are sitting on their money because they see an uncertain economic future. Creditor households are reluctant to buy new cars or get their kitchens remodeled lest they lose their jobs in the future. Creditor firms, meanwhile, are reluctant to build new plants since they cannot see how they would be able to sell all the new production coming from those plants. Similarly, creditor banks are not increasing lending as there is little demand for funds and few creditworthy borrowers.
If these creditor households, firms, and banks all simultaneously started spending their excess money balances, this would increase total current-dollar spending and in turn spur a real economic recovery. Moreover, knowing that the real economy would improve would feed back and reinforce current spending decisions by the creditors — creditor households would buy new cars and remodel their kitchens, creditor firms would build new plants, and creditor banks would increase lending. A virtuous cycle would take hold and push the economy back toward full employment. But this virtuous cycle is not taking off because creditors are still hanging on to their money balances. What is needed to kickstart this cycle is an entity powerful enough to incentivize all the creditor households and firms to start spending their money simultaneously.
Enter the Federal Reserve. It alone has the ability to provide these incentives through its control of monetary policy. The fact that total current-dollar spending has remained depressed for so long means that the Federal Reserve has failed to do its job and effectively has kept monetary policy too tight.
The solution, then, is for the Fed to use monetary policy to change nominal expectations in a way that solves the excess money demand problem. Here is how I would have the Fed do it.
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