I haven't seen too many people try to calculate how big a recession we need to have -- i.e., if the government manages both to prevent a short-term liquidity crisis from wiping out half the economy and if the government doesn't inflate us into a new bubble that just means we'll have a bigger reckoning later. In other words, under the best case scenario, how much does the economy have to contract?
A super simple model would be to look at how much poorer we turn out to be than we thought we were. For example, say our wealth, such as real estate and financial instruments, is actually worth only 70% of what we thought it was worth 18 months ago.
Then, how does the wealth effect translate into economic activity? People who were taking vacations to Las Vegas by refinancing their mortgage to tap their rise in home equity probably aren't going to be going to Las Vegas for awhile.
If we're, say, 30% poorer now than we thought we were, how much less economic activity does that support? That's a difficult question, but it seems like one that's guessable.
So, just to toss out a round number, let's say that 70% as much wealth translates into a 90% as large a GDP.
So, what kind of recession does that look like? Say, a three percent decline in GDP for three straight years. That's a humongo recession. And that's the best case scenario.
Of course, I just made all those numbers up out of thin air.