Recessions begin because a string of large-scale business investments prove to be unsustainable in light of real economic conditions. Why would so many entrepreneurs make the same mistake at the same time? Because the government and its central bank — the Federal Reserve — create misleading signals in the form of artificially low interest rates and (before the most recent recession) artificially high demand for housing. These policies fool entrepreneurs into thinking that consumers are saving rather than spending, that is, deferring consumption until the future. Businesses then use the easy credit for long-term interest-rate-sensitive projects, such as housing and stages of production remote from the consumer-goods level. Yet consumers have not curtailed spending.
The recession sets in when interest rates rise and the cluster of errors is revealed. The malinvestments are liquidated, and workers are laid off. If the economy is to recover, the structure of production must be realigned with real economic factors, including people’s consumption/saving preferences. This is a costly and time-consuming process because workers may need retraining, buildings may need modifying, and machinery may need to be moved or junked. Government policy misshaped the economy, which now must be reshaped into something more appropriate.
Government’s only proper task is to get out of the way so that the recovery can be as fast and painless as possible.