"We can't predict how deep the recession will be, or how long it will last, because it depends on psychology. "

Another good post from the Guardian:

"Bill Emmott

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• The Guardian, Saturday 3 January 2009
• Article history

"What, pray, is all the fuss about?" asked a sage columnist in these pages on the first anniversary of the credit crunch ("Crisis, what crisis?", 12 August). In response to claims that this was a great crisis of capitalism he even deployed the word "phooey". That sage columnist was of course yours truly; it is safe to say that article will not be pasted into my scrapbook titled "Most Prescient Pieces".

My argument was, of course, correct in so far as it looked in the rear-view mirror rather than at the road ahead. The striking thing about the first year of the crunch, in Britain and globally, was how little impact it had on the wider economy beyond the banks, the City and Wall Street( TRUE ).

And any impact that has yet been seen does not make the situation worse than the recession of the early 90s, or especially the early 80s, when unemployment was nearly double today's level. Still, it is no longer possible to be as sanguine as I was in August. We are still far from a "worst since the 30s" situation, but there is no doubt that in the last four months all developed economies, and many developing ones, have frozen up. How bad might it get? We don't know, because we can't know.( TRUE )

It is worth dwelling for a moment (as I have for many moments, especially since mid-September) on why I was proved so wrong. There are, I think, two reasons beyond idiocy or complacency.

First, I may have spent too much time thinking about Japan. It really did have the rich world's worst financial crisis since 1929, when after 1990 its stockmarket fell by 75% and property prices by 70%. But it never had a severe recession: more a slow squeeze that ended, from 1997 onwards, in deflationary stagnation. A slump was prevented by a huge Keynesian public spending programme; meltdown was prevented by using public funds to rescue banks.

The collapse of our financial pyramid scheme could be absorbed, I thought, by learning from Japan's example and improving on it. That is exactly what Gordon "saviour of the world" Brown did by recapitalising Britain's banks 14 months into the crisis, rather than waiting eight years, as Japan had; and it is reflected in the fiscal expansion announced in Alistair Darling's pre-budget report in November and the huge spending programme being prepared by the US president-elect.

However, our drama now feels worse than Japan's because it is international. Japan's economy was propped up by healthy global growth, whereas now we are all slowing or receding together. It is also worse because of the second factor that I misjudged in August: psychology( THE KEY TO THE WHOLE CRISIS ).

The position I took was, in effect, an attempt to argue that we risked talking ourselves into recession, through media scaremongering, and remarks such as Darling's warning, in his Guardian interview of 29 August, that Britain faced the worst economic times for 60 years, with more "profound and long-lasting" effects than people were expecting. No doubt he now thinks he has been proved correct, while I still hope that he won't be, and feel he may have contributed to the panic( TRUE. BUT IT'S UNDERSTANDABLE. ) - even though it would be implausible to argue that he caused it.

Now fear has taken over( THE FEAR AND AVERSION TO RISK ). Companies, households and banks have decided that cash must be king, to be in debt is to risk death, and new commitments are best avoided. Individually, this is rational. Collectively, it is disastrous( TRUE ). Or, to avoid being a scaremonger, it brings about( I AGREE ) the thing we are afraid of: a nasty recession.

We can't predict how deep the recession will be, or how long it will last, because it depends on psychology( I AGREE ). Economics is not about models and mathematics, it is about behaviour( THAT IS THE WHOLE POINT OF A HUMAN AGENCY EXPLANATION ): our reactions to opportunities, risks and fears.

Brown and Darling are right to be trying to counter that deflationary psychology( TO TRY AND LESSEN THE AVERSION AND FEAR OF RISK ) by throwing away the old fiscal rules, cutting VAT and expanding public borrowing. Like in Japan, this will help to mitigate the slump. But whether it can end the slump will depend on companies, households and banks that hold cash being convinced( YES ) that it is time to start spending again - because they have become sufficiently less afraid of an apocalypse, and sufficiently convinced that opportunities to invest, buy and lend have become sufficiently attractive( YES ).

Meanwhile, note, this is not - yet - a true "crisis of capitalism"( I AGREE ). That would arise if confidence never seems likely to return, if unemployment has soared( A TRUE DISASTER ) and if hope seems truly to have been destroyed. It cannot be ruled out( I AGREE ). But let us, as the future US president said in his book, have the audacity to hope that it won't happen, and the sense not to announce it until and unless it does.

• Bill Emmott is a former editor of the Economist and author of Rivals - How the Power Struggle between China, India and Japan will Shape our Next Decade"

I agree with this post and its emphasis.