“What the world needs right now is a rescue operation. The global credit system is in a state of paralysis, and a global slump is building momentum as I write this. Reform of the weaknesses that made this crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policymakers around the world need to do two things: get credit flowing again and prop up spending.
The first task is the harder of the two, but it must be done, and soon. Hardly a day goes by without news of some further disaster wreaked by the freezing up of credit. ...
Even if the rescue of the financial system starts to bring credit markets back to life, we'll still face a global slump that's gathering momentum. What should be done about that? The answer, almost surely, is good old Keynesian fiscal stimulus. ...
I believe not only that we're living in a new era of depression economics, but also that John Maynard Keynes—the economist who made sense of the Great Depression—is now more relevant than ever. Keynes concluded his masterwork, The General Theory of Employment, Interest and Money, with a famous disquisition on the importance of economic ideas: "Soon or late, it is ideas, not vested interests, which are dangerous for good or evil."
We can argue about whether that's always true, but in times like these, it definitely is. The quintessential economic sentence is supposed to be "There is no free lunch"; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes's world—and ours—was therefore not of resources, or even of virtue, but of understanding.
We will not achieve the understanding we need, however, unless we are willing to think clearly about our problems and to follow those thoughts wherever they lead. Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.”
Paul Krugman, “What to do”, The New York Review of Books (Yet to be formally published, 18 December 2008).
Paul Krugman (1953-) is a professor of economics and international affairs at Princeton University, and a columnist for The New York Times. Earlier this year he won the Nobel Memorial Prize in Economic Sciences "for his analysis of trade patterns and location of economic activity".
Paul Krugman is at once one of the best and one of the most controversial economists commenting on economic affairs today. There is no doubt that his academic accomplishments in the areas of trade theory, economic geography, and international finance are worthy of a Nobel Prize. And there is no doubt that he is more than outspoken in his opposition to ideas he does not like, often in a "shrill" rhetorical style, wins him few friends among the many he attacks. In this regard, he has been among the harshest critics of the Bush Administration.
As is reflected in this except, Krugman is a strong Keynesian and calls, in typical Keynesian fashion, for government measures to boost aggregate demand. He would no doubt approve of a coordinated fiscal stimulus from many countries to boost the global economy. In yesterday’s Tdj, I expressed reservations about this approach. I add here that increased spending takes time to approve, more time to implement (especially, when the new spending takes the form of public works projects, such as those now being advocated), and even more time yet to have an impact on the economy. Fiscal policy is not a short-term measure.
The world economy is now sinking and sinking rapidly. World manufacturing production is tumbling, with reports much weaker than expected. New car sales are down across the world. Exports are shrinking. Consumer and business confidence is falling everywhere. Exchange rates are increasingly volatile. And of course the financial crisis, which is world-wide in scope, continues unabated. No one knows when the bottom will be reached and a recovery might begin. Some people think it will be some time.
From the discussions now taking place at the national and international level, governments and international agencies think the downturn will be steep and prolonged. It would appear the strategy now being formulated for dealing with a global recession consists of measures and actions to be taken over three time horizons: In the short-term, immediate attention focuses on restoring confidence in the financial system by recapitalizing financial institutions and attempting to overcome the problems created by a liquidity trap, nationally by guaranteeing loans and mortgages and internationally by bilateral currency swaps to ensure foreign currency liquidity; Over the medium-term, measures to sustain demand, such as a very loose monetary policy and a fiscal policy that includes cutting taxes and increasing spending, are being advocated; Looking to the longer-term, attention will be directed at reforming the regulatory and supervisory frameworks of financial markets to reduce systemic risks, improve financial intermediation and allow for better coordination among countries.
In my view, Krugman will get his wish. There will be a lot of government spending in our future and the future of other countries. But it will take time to put spending measures into effect and one has to wonder if in the end they will be any more effective than the efforts to get credit flowing again have been. My suspicion is all the spending will not help; indeed, I think it might even further unbalance the economy. In my view, we would be better off just stabilizing the policy environment by setting sensible rules for taxes, business activity and government spending and telling the public the rules are not going to change for the foreseeable future.
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