Lectures on Macroeconomics, No. 11, Arnold Kling | EconLog | ...

The first type of effective demand failure is a shortage of "animal spirits." No matter how much people want to save, entrepreneurs don't have projects that they want to pursue. The result is that instead of an increase in investment, we see a decline in output.

The second type of effective demand failure is what I think of as the standard multiplier effect. When people lose their jobs, they cut back on consumption.

The third type of effective demand failure is a credit crunch. Entrepreneurs want to engage in projects with reasonable risk-return trade-offs, but banks are busy shoring up their own balance sheets.

I think that in the United States today, we do not have a shortage of "animal spirits." We have a credit crunch. But we have something else, not included in AL's list. We have savers suddenly wanting a lower ratio of risky assets to risk-free assets. This is somewhat akin to Keynes' liquidity preference. It reinforces the credit crunch.

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