Governments usually respond to recessions by adopting expansionary macroeconomic policies, such as increasing money supply, increasing government spending and decreasing taxation.In the United States, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) is generally seen as the authority for dating US recessions.Government stimulus spending and mercantilist policies to stimulate exports and reduce imports are other techniques to stimulate demand.Behavior that may be optimal for an individual (e.g., saving more during adverse economic conditions) can be detrimental if too many individuals pursue the same behavior, as ultimately one person's consumption is another person's income.When these relationships become imbalanced, recession can develop within the country or create pressure for recession in another country.Policy responses are often designed to drive the economy back towards this ideal state of balance.Such expectations can create a self-reinforcing downward cycle, bringing about or worsening a recession.The term animal spirits has been used to describe the psychological factors underlying economic activity. Shiller wrote that the term "...refers also to the sense of trust we have in each other, our sense of fairness in economic dealings, and our sense of the extent of corruption and bad faith.
Despite zero interest rates and expansion of the money supply to encourage borrowing, Japanese corporations in aggregate opted to pay down their debts from their own business earnings rather than borrow to invest as firms typically do. In a balance sheet recession, GDP declines by the amount of debt repayment and un-borrowed individual savings, leaving government stimulus spending as the primary remedy.
However, if too many individuals or corporations focus on saving or paying down debt rather than spending, lower interest rates have less effect on investment and consumption behavior; the lower interest rates are like "pushing on a string." Economist Paul Krugman described the U. 2009 recession and Japan's lost decade as liquidity traps.
One remedy to a liquidity trap is expanding the money supply via quantitative easing or other techniques in which money is effectively printed to purchase assets, thereby creating inflationary expectations that cause savers to begin spending again.
Koo argues that it was massive fiscal stimulus (borrowing and spending by the government) that offset this decline and enabled Japan to maintain its level of GDP. In other words, people would tend to spend more rather than save if they believe inflation is on the horizon.
In more technical terms, Krugman argues that the private sector savings curve is elastic even during a balance sheet recession (responsive to changes in real interest rates) disagreeing with Koo's view that it is inelastic (non-responsive to changes in real interest rates).
A severe (GDP down by 10%) or prolonged (three or four years) recession is referred to as an economic depression, although some argue that their causes and cures can be different. In the US, V-shaped, or short-and-sharp contractions followed by rapid and sustained recovery, occurred in 19–91; U-shaped (prolonged slump) in 1974–75, and W-shaped, or double-dip recessions in 19–82.