Paul Krugman’s new and remastered Depression Economics from 2009 offers his critical assessment of the 2008 global financial crisis as viewed from the lens of financial economics, laid out to be a fairly easy read for people without a degree in economics. He starts with the Great Depression of the 1930 and his somewhat comical analogy of the “baby-sitting coop” and then uses that same model to lead the reader through the multiple recent crises around the world that, according to Krugman, should have been a signal to the bankers and economic policymakers worldwide that something is wrong with the system. After this very well-presented historical analysis, he offers his solution to the crisis that is neither very detailed nor complex, and should seem like a no-brainer to anyone familiar with Keynesian economics. The solution he offers also seems to be an extension of something that is commonplace in Europe, for example, and “depression economics” ends up being more of a pretty rhetoric than any sort of groundbreaking new economic theory.
Krugman identifies two main reasons for financial crises. First is the easy access to credit and moral hazard as a negative side-effect. It goes like this – first, for whatever reason, the credit starts flowing actively. Eventually, because of “easy money”, as well as insurance against risk, the people start to invest in riskier enterprises for higher yield. As a result, the whole system becomes more responsive to “self-fulfilling panics” that can get powerful enough to result in a domino effect, breaking the bubble and plunging the economy into a recession. That is when the second problem comes in – the issue present since the Great Depression in various forms, despite the changes in the financial system, the “liquidity trap”. The trap could have various reasons – an economic system based on a fixed exchange rate like the gold standard in the 30s, or the fixed dollar exchange rates in Argentina or South Asia, which lead to limitations based on the amounts of reserves available; another one would be a tight economic policy, or reaching the interest rate of zero without revitalizing the economy. This is Krugman’s “depression economics”, the situation where in is the demand side that fails the economy, and the traditional supply-side approach is unable to help (182). Krugman then proceeds to bring out the analogy from all the earlier crises to the current worldwide slump, and the role the “shadow economy” has played in it.
Now, this is a very well laid-out comparative perspective that is difficult to find holes in. In some ways, it is easy to blame Krugman for the use and abuse of the benefit of hindsight some reviews accuse him of; I would argue that a childish “told you so” is not really the main point of the book. The goal is rather to show that crises like these are easily prevented with a correct approach, and that it is possible to plan ahead based on the historical analogies to prevent the trouble before it ever happens. To be fair, the comparison that Krugman engages in is probably worth more as an insight than suggestions for future actions; still, it was quite disappointing to find such an inconclusive ending to such a great assessment. The no-brainer “exercise more control in the unregulated areas” and “use more stimulus money” suggestion may be useful, but Krugman does not bother to present them in an appealing or even asserting way. One may also see a problem with the “recovery first, reform second” approach. Here is why it may not work: for the same reasons why the IMF only has real power during crises; in short, if the recovery proceeds smoothly, the reform is likely to be overlooked. One may blame FDR for his “Roosevelt depression”, but at least it insured that a new system is installed, one that lasted for a good 60-70 years without major trouble.
Getting the credit flowing now with massive stimuli (4-6% GDP, on Krugman’s suggestion) may only further unbalance the market. First, it will stimulate even more moral hazard, the banks and companies having ever more trust in the government “bailout”. Second, will it not start yet another bubble? (Krugman seems to realize this, but not elaborate, resorting to an Onion reference instead) How long will it take till a bubble big enough to throw even a giant like US into a “Japan trap” comes around? An economy dependent on constant succession of bubbles is like a drunken man constantly staggering but not quite falling down. Shouldn’t we rather look to the root of the problem before caring to fix the short-term consequences?
Finally, Krugman’s book can be a perfect manual for the opponents of globalization. The author himself does not go much into this, but the conclusion is pretty obvious – first the Asian countries in the 90s, then the whole world today has seen economic interdependence turn what may have been minor domestic issues into a big worldwide problem. On the other hand, China, a country that tries to control globalization to fit its own interests, with its strict controls on currency exchange and overall government controls on the market economy, is about the only country to still have a significant positive GDP growth (8%), despite the global recession. If the lack of regulations and moral hazard are at fault for starting the crises, globalization is surely responsible for exacerbating them, according to Krugman.
Sadly, Krugman offers little to no political commentary for the current situation in the US and worldwide. We may know of the existence of an economic remedy, and feel the dire need to implement it, but sadly economics do not always come first, even in democratic countries with market economies. The small first stimulus package (small enough to be of little use) is one great example to the politicians caring more about the short-term public response and political ideology rather than long-term economic benefit. The crisis may also change how the different countries relate to each other on the international political scene. These are just some minor (but important) side-stories worth exploring.
In the end, I think Krugman succeeds in laying out a decent framework for future research, but fails to construct an effective argument of his own. Then again, perhaps a 200-some-page book cannot really do justice to such an extensive topic in the first place.
