Krugman describes the economy and what needs to be done

Paul Krugman today gave a good description of the current economy and how we got here.

Just this week, we learned that retail sales have fallen off a cliff, and so has industrial production. Unemployment claims are at steep-recession levels, and the Philadelphia Fed’s manufacturing index is falling at the fastest pace in almost 20 years. All signs point to an economic slump that will be nasty, brutish — and long.

How nasty? The unemployment rate is already above 6 percent (and broader measures of underemployment are in double digits). It’s now virtually certain that the unemployment rate will go above 7 percent, and quite possibly above 8 percent, making this the worst recession in a quarter-century.

And how long? It could be very long indeed.

Think about what happened in the last recession, which followed the bursting of the late-1990s technology bubble. On the surface, the policy response to that recession looks like a success story. Although there were widespread fears that the United States would experience a Japanese-style “lost decade,” that didn’t happen: the Federal Reserve was able to engineer a recovery from that recession by cutting interest rates.

But the truth is that we were looking Japanese for quite a while: the Fed had a hard time getting traction. Despite repeated interest rate cuts, which eventually brought the federal funds rate down to just 1 percent, the unemployment rate just kept on rising; it was more than two years before the job picture started to improve. And when a convincing recovery finally did come, it was only because Alan Greenspan had managed to replace the technology bubble with a housing bubble.

Now the housing bubble has burst in turn, leaving the financial landscape strewn with wreckage. Even if the ongoing efforts to rescue the banking system and unfreeze the credit markets work — and while it’s early days yet, the initial results have been disappointing — it’s hard to see housing making a comeback any time soon. And if there’s another bubble waiting to happen, it’s not obvious. So the Fed will find it even harder to get traction this time.

So what can be done for the economy?

It should be clear to the most extreme free market ideologues right now that the free market is frozen in place. we call it "the Credit Crisis." What that means is that no one who has money to lend dares lend it to someone who needs cash to operate their business because the lender has no clue which potential borrower is going to go bankrupt tomorrow morning and default on tonight's overnight loan. There is no free market solution to this problem. Worse, while the credit crisis freezes borrowing, the real economy goes into a downward spiral that feeds back into the very pressures that have frozen lending.

The solutions to the current economic problems are Keynsian. John Maynard Keynes laid them out in his 1936 book. Tax cuts will not work because there is no consumer demand for businesses to sell to because consumers don't have the money to buy with, and especially because consumers with good sense are not going to borrow money to jack up consumption spending this time around. The fear of economic collapse already prevents that. So - back to Krugman for the solutions:

In other words, there’s not much Ben Bernanke can do for the economy. He can and should cut interest rates even more — but nobody expects this to do more than provide a slight economic boost.

On the other hand, there’s a lot the federal government can do for the economy. It can provide extended benefits to the unemployed, which will both help distressed families cope and put money in the hands of people likely to spend it. It can provide emergency aid to state and local governments, so that they aren’t forced into steep spending cuts that both degrade public services and destroy jobs. It can buy up mortgages (but not at face value, as John McCain has proposed) and restructure the terms to help families stay in their homes.

And this is also a good time to engage in some serious infrastructure spending, which the country badly needs in any case. The usual argument against public works as economic stimulus is that they take too long: by the time you get around to repairing that bridge and upgrading that rail line, the slump is over and the stimulus isn’t needed. Well, that argument has no force now, since the chances that this slump will be over anytime soon are virtually nil. So let’s get those projects rolling.

This is ideologically very unpalatable to the Bush administration conservatives, which is why they have done so little that is effective to head off or ameliorate the current recession.

The conservative ideology has to be thrown aside. It has caused the current economic problems, and it will only make them worse.