The Return of Depression Economics and the Crisis of 2008
Products for Sale — By Shopping Blogs on May 2, 2010 1:27 am
- ISBN13: 9780393337808
- Condition: NEW
- Notes: Brand New from Publisher. No Remainder Mark.
Product Description
The New York Times bestseller: the Nobel Prize–winning economist shows how today’s crisis parallels the Great Depression—and explains how to avoid catastrophe. With a new foreword for this paperback edition. In this major bestseller, Paul Krugman warns that, like diseases that have become resistant to antibiotics, the economic maladies that caused the Great Depression have made a comeback. He lays bare the 2008 financial crisis—the greatest since the 1930s—tracing it to the failure of regulation to keep pace with an out-of-control financial system. He also tells us how to contain the crisis and turn around a world economy sliding into a deep recession. Brilliantly crafted in Krugman’s trademark style—lucid, lively, and supremely informed—this new edition of The Return of Depression Economics has become an instant classic. A hard-hitting new foreword takes the paperback edition right up to the present moment. .
The Return of Depression Economics and the Crisis of 2008
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Tags: depression economics, paul krugman, remainder mark
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This is a slim book (<200 pages with big font and wide line spacing) that covers a lot of material. While I like Paul Krugman's clear, informal writing style and use of analogies to past crises, I didn't find these episodes to be explored as deeply as I would have liked. This book seems more suited to people who are new to macroeconomics. For example, the babysitting coop analogy is a classic, and still one of the clearest, simplest ways to explain the interaction between monetary policy, aggregate demand, and consumer behavior. More data and a few charts would have helped to illustrate the economic and market conditions around the asian and latin american crises, and helped to put the magnitude of these (and the current crisis) in perspective. I liked his discussion of when the severity of some crises seem disproportionate to what fundamental conditions would initially suggest, which sounds a lot like soros' reflexivity (e.g. people perceive a bank to be bad (whether accurate or not), pull their money, cause a run, bank fails, => people create the conditions in which their fears are realized).
Overall, this is a quick easy read, helpful as a concise, clearly written primer on what been going on recently.
Rating: 3 / 5
Depression economics is when conventional economic wisdom no longer applies. In a “normal” recession the Federal Reserve would lower interest rates in order to stimulate consumption and investment. According to Paul Krugman, that remedy is no longer getting any traction. He claims it’s time to cast conventional economic wisdom to the wind. The economy is in such a deep hole that he’s calling for another $600 billion in federal outlays. This is in addition to the $700 billion already asked for by Treasury Secretary Paulson, and looks very similar to Obama’s spending plans for next year.
This is a re-issue of a book written by Krugman in 1999 after multiple economic crises in the decade of the 1990s. Japan had just lost a decade’s worth of growth for responding too timidly to the bursting of their stock and real estate bubbles. Krugman also analyzes the various currency crises of that decade: from Britain and Sweden in the early 90s, to Mexico and Argentina in the mid-90s, and finally to Brazil and East Asia in the late 90s. These crises occurred as globalization was doing its work in the currency markets.
In his analysis of Japan’s lost decade, he argues that everything must be done to increase aggregate demand. The collapse of demand caused by loss of confidence and fear had severely depressed spending and investment. At that point only government spending can lessen the severity of the recession and perhaps even turn the economy around. In Krugman’s view, the lackluster response was the reason it took Japan so long to recover. He believes that one should only worry about deficits and debt when the economy is on the rebound. (This is completely contrary to what Robert Samuelson advises in The Great Inflation and Its Aftermath: The Past and Future of American Affluence.)
Krugman claims that the financial crises of 2008 is “functionally similar” to the Great Depression. He does not believe, however, that it will be as severe. We now have the financial tools and institutions – and the hindsight – to make for a softer landing. Nevertheless, this crisis has no end in sight yet. The one big thing that everyone seems to know now is that one does not increase taxes and implement budget cuts during a crisis, as Herbert Hoover did. And which FDR did several years into the Depression.
Another lesson that Krugman derives from the 90′s is the need for greater regulation. As one country after another experienced currency problems from investor flight, there was one country that did better than others to weather the storm: that country was Malaysia. It’s leader Mahathir Muhammed was of the same mind as Krugman. Managing the capital flows in and out of the country will soften the blows, should foreign investors decide to pull out. The conventional wisdom of the time was that price stability and currency convertibilty were the only things needed, and that the market would take care of the rest. However, in this case, a little more regulation saved them from a crisis.
Depression economics goes against the grain of conventional economic wisdom, and given the current crisis it is coming back into fashion, even among those who preached deregulation and fiscal restraint a decade ago. This theory should be applied sparringly, only in extreme cases – the present crisis probably qualifies. It should not be applied to every minor recession that comes along. The danger of overuse of depression economics is that it can cause a toxic brew of inflation and stagnation – not to mention corruption.
Rating: 4 / 5
I did not come to this book with high expectations. I am conservative, and Paul Krugman, of course, is a highly visible liberal. I expected some sort of left-wing soft-headedness.
I was surprised by the quality of what I read. The content of the book was quite different than I had anticipated, and Krugman’s path to his expected ringing endorsement of Keynes was not at all what I would have expected.
Most of the book has nothing to do with the current crisis. Instead, he goes through a series of vignettes about the international crises of recent decades, from the various Latin American debt crisis to those in East Asia and Japan to the Russian one. In each case, he builds a growing argument that, with the increased interconnectedness of the international financial system, national economies have become peculiarly vulnerable to panics by investors which destroy their finance systems.
He then ties this into an explanation of the current crisis. He argues that the U.S. economy has become like that of the other countries who went through financial crises. In our case, however, the problem was not that the world economy is more interconnected. Instead, in our case the problem is that the growth of the shadow banking industry built up a huge bubble, due to the non-banks not being regulated. He draws a convicing paralled with the Panic of 1907 by noting how that panic was caused by the non-banks of that time, the trust companies, which had far less oversight.
He concludes by arguing that what we need is: (1) a huge dose of fiscal spending to stimulate the economy; and (2) regulation of the non-banks.
All in all, it is a powerful performance. Krugman writes extremely well, and he is very persuasive. However, certain problems kept gnawing at me as I read the book.
First, Krugman never really explains the earlier crises in Latin America and East Asia, nor does he ever really connect them to our situation. He keeps using the technique of saying that, well to understand why the Mexican economy blew up, you need to understand X, which we will get to in the next chapter on Thailand. He keeps rolling over his explanations, and I ended up feeling flummoxed. I actually found each of the stories quite interesting, but I never felt like he really explained any of them properly. He also never really says why our current crisis has anything much to do with the Mexican or Thai crises.
Second, Krugman has a very persistent bias against explaining economic downturns by looking at the failure of prices to fall. As Krugman acknowledges in the last chapter, classical economic theory says that recessions should fix themselves. How? As the economy slows, prices and wages should fall. As prices fall, more people should buy. As wages fall, more people should be hired. The problem should fix itself.
Krugman mentions this in his last chapter. He also says that, in reality, prices do not fall much in recessions, and why this is so is a mystery much debated among economists. I find that pretty lame, on two of his central subjects: the Great Depression and the collapse of the Japanese bubble economy. I recently read Smiley’s book on the Great Depression. He argues very persuasively that a recession turned into a prolonged recession, precisely because — unlike earlier downturns in which prices and wages did fall — they did not fall in the Great Depression, because both Hoover and FDR labored mightily to keep them up. Smiley also agrees with Krugman that monetary policy was disasterously restrictive in the Great Depression, but he is quite clear that a great deal of the problem was policy interference in the market which kept prices and wages artificially high.
Likewise I have some familiarity with the Japan bubble economy and its aftermath, having worked for an international law firm at that time. I watched both the Japanese crash and the American S & L crisis, which happened pretty close to each other in time. The key difference that I saw was, while real estate prices crashed in both countries, in America we admitted this, whereas the Japanese denied it. We let prices crash, let the S & Ls go bankrupt and used the RTC to clean up the mess. The Japanese, on the other hand, propped up their banks by refusing to admit that the real estate collateral supporting their loans was increasingly worthless. As a result, real estate prices did not fall as much as they should have, banks did not go bust as they should have, and a temporary downturn turned into a longterm national decline.
I also think that Krugman’s time frame, in arguing that prices do not fall in a downturn, is relatively short. I believe it is accurate to say that, in the economic downturns starting with the Great Depression, prices have tended to be quite resistant to falling, even in recessions. This was NOT true in economic downturns in the 19th and early 20th century, all of which fixed themselves in the classic manner, of prices and wages falling and the market thus recovering.
All of this tells me that, in downturns, one of the key things is to let prices fall, so the market can find a bottom. Krugman seems oblivious to this, or hostile to it. It is a major hole in his analysis.
I have mixed feelings about his policy ideas. I am not enthusiastic about another big stimulus package, as he is. It seems to me that if deficit spending was going to fix the economy then we should not have had a problem to begin with, because we have had plenty of deficits. But, I am not sure that fiscal stimulus, in a controlled manner, is necessarily a bad thing, short-term. I also totally agree with him that the non-banks should be regulated. If we have to bail them out when they fail — and we just did — we should regulate them in good times.
Rating: 4 / 5
Large parts of this book accurately describe some processes which contribute to financial crises, but he fails to describe enough of what happened in crises such as in 2008 to reach sensible policy advice.
He presents a simple example of a baby-sitting co-op that experienced a recession via a Keynesian liquidity trap, and he is right to believe that is part of what causes recessions, but he doesn’t have much of an argument that other causes are unimportant.
His neglect of malinvestment problems contributes to his delusion that central banks reach limits to their power in crises where interest rates approach zero. The presence or absence of deflation seems to provide a fairly good estimate of whether liquidity trap type problems exist. If you recognize that malinvestments are part of the problem that caused crises such as that of 2008, the natural conclusion is that the Fed solved most of the liquidity trap type problem within a few months of noticing the severity of the downturn. There is ample reason to suspect that the economy is suffering from a misallocation of resources, such as workers who developed skills as construction workers when perfect foresight would have told them to develop skill in careers where demand is expanding (nurses?). Nobody knows how to instantly convert those workers into appropriate careers, so we shouldn’t expect a quick fix to the problems associated with that malinvestment. It appears possible for he Fed to make that malinvestment have been successful investment by dropping enough dollars from helicopters to create an inflation rate that will make home buying attractive again. Krugman’s suggested fiscal stimulus looks almost as poor a solution as that to anyone who sees malinvestment as the main remaining problem.
His claim that central bank policy is ineffective is misleading because he pretends that controlling interest rates is all that central banks do to “stimulate” the economy. If instead you focus on changes in the money supply (which central banks can sometimes cause with little effect on interest rates), you’ll see they have plenty of power to inflate.
He dismisses the problem of sticky wages as if it were minor or inevitable. But if you understand the role that plays in unemployment, and analyze Singapore’s policy of automatically altering payroll taxes to stabilize jobs, you should see that’s more cost-effective than the fiscal stimulus Krugman wants.
I’m not satisfied with his phrasing of lack of “effective demand” being caused by people “trying to accumulate cash”. If we apply standard financial terminology to changes the value of a currency (e.g. saying that there’s a speculative bubble driving up the value of the currency, or that there’s a short squeeze – highly leveraged firms have what amounts to a big short position in dollars), then it seems more natural to use the intuitions we’ve developed for the stock market to fluctuations in currency values.
He doesn’t adequately explain why most economists don’t want a global currency. He says labor mobility within the area that standardizes on a currency is important for it to work well. I’m unconvinced that much mobility is needed for a global currency to work better than the mediocre alternatives, but even if it is, I’d expect economists to advocate a combination of a global currency and reducing the barriers to mobility. How much of economists dislike for a global currency is due to real harm from regional fluctuations and how much is it due to politicians rewarding people like Krugman for biasing their arguments in ways that empower the politicians? Or do they not give it much thought because they’ve decided it’s politically infeasible even if desirable?
His description of the shadow banking system clarifies quite well how regulatory efforts to avoid crises failed. His solution of regulating like a bank anything that acts like a bank would work well if implemented by an altruistic government. But his “simple rule” is too vague for his intent to survive in a system where politicians want to bend the rules to help their friends.
Rating: 4 / 5
I had mixed feelings about this book — I liked it, but I didn’t think it worth 5 stars and I toyed with giving it just 3 stars. A brief rundown of the pros and cons, starting with the cons.
In the intro, Krugman says this is a book of interpretation. (I guess as opposed to fact.) This apparently leads Krugman to think he’s off-the-hook in having to do any research. He does present facts in the book, or at least things that look like facts, but they appear to have come from memory. Which I guess is why there are no footnotes or bibliography — he probably didn’t recall how he came across a particular fact. The lack of any references also does nothing to help the reader interested in doing further research into the topic. And the lack of an index furthers the impression that this edition was a rush job.
On the pro side: Krugman is a smart cookie who understands a lot more about the current financial/economic situation than those othodox macroeconomists regularly quoted in the press, who don’t seem to have a clue. (Two of whom actually wrote widely used textbooks on the subject, which says something about the state of economic thought in this country.) I found particularly interesting Krugman’s interpretation of the Asian (and South American) financial panics/crashes of the 1990s and how they relate to the current situation.
Krugman’s conclusion is that we are not in a depression — at the time he wrote the book — and hopes we won’t get into one, but that the economic forces at work are those of “depression economics”, as opposed to economic forces active in typical business cycle recessions. The key difference is the collapse of the financial structure.
So, the upshot is, the reader will get some good insights here that would be difficult to get elsewhere.
Rating: 4 / 5
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