Recession

You technically can't say we are in a recession until the NBER calls it, and so far I don't think they've called it. But, I'm going to just call it anyway. Consumer spending is falling equal lo tov thus saith the Hebrews.

My only knowledge of macroeconomics is from Bernanke's principles textbook. I don't even recall the IS-LM model, and even that is antiquated! So my simple AD/AS model, which I think is some kind of special case of the IS-LM model though I'm not sure, is incomplete. But the story goes like this. We're in longrun equilibrium, something causes potential spending to fall. Let's say it's falling house prices, and falling investment due to difficulty in acquiring credit from banks. This shifts the aggregate demand curve left, and real GDP falls below potential GDP. The longrun equilibrium is reached as inflationary expectations result in prices falling and in turn inflation falling as the Fed responds to falling prices by decreasing nominal interest rates. The Fed is currently lowering nominal interest rates, or attempting to, via the fall in the federal funds rate, but consumption is apparently continuing to fall, and I think so is Investment, and possibly net exports due to the appreciation of the US dollar. So, all things considered, the typical responses of fiscal and monetary stimulus - do they work in this situation? Those things are meant to address issues where people start hoarding cash, or rather, reduce their spending, and the multiplier dynamics in the economy cause that reduction in spending to be "multiplied" through a money multiplier equal to one over one minus the marginal propensity to consume, which appears to be therefore a very large number given Americans low savings rate. All in all, I think I can see the simple Keynesian model, but it waves a lot of hands over financial insolvency, so I wonder how principles teachers are teaching this material this semester. I'm sure it's both exciting and a little nerve-wracking, as when you get to the chapter on the Fed, where it says they are the lendor of last resort, you're not really sure how to explain the AIG acquisition or the bailouts, or anything. And then what can be done to explain the proper response to a recessionary output gap when it's being driven by insolvency in the financial sector. Can you just lower taxes or increase transfers without actually addressing the insolvency issue? It doesn't seem like you can.