Krugman on Depression Economics

Paul Krugman discusses the current economic woes today, with a mixture of concern and some optimism.

The economic news, in case you haven’t noticed, keeps getting worse. Bad as it is, however, I don’t expect another Great Depression. In fact, we probably won’t see the unemployment rate match its post-Depression peak of 10.7 percent, reached in 1982 (although I wish I was sure about that).

We are already, however, well into the realm of what I call depression economics. By that I mean a state of affairs like that of the 1930s in which the usual tools of economic policy — above all, the Federal Reserve’s ability to pump up the economy by cutting interest rates — have lost all traction. When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly.

Go read his column for the details. As usual it is accurate and well written.

The key statement which I highlighted above, however, is going to be what the politics of government aid to recovery revolves around. The "Hell! No!!" Republicans and some of the Blue Dog conservative Democrats are not going to get the picture.

They are going to be fighting, clawing and scratching, to continue to old rules they have been practicing for three decades, the ideological market fundamentalist rules that have caused the economic crisis America and the world now face.

Plan on it. That dynamic is going to be central to Washington politics for the next two or more years. To the extent that conservatives prevail and bold action is NOT carried out, the recovery will be delayed.

Note: That does not mean that "bold action" per se will succeed in initiating or speeding economic recovery. We are in unknown waters, and there is every chance that actions that are decided on simply will not work. What is clear, however, is that not acting and that when acting, acting less than boldly, clearly will be useless and destructive to the economy.

On the subject of bold action, Krugman says this:

To pull us out of this downward spiral, the federal government will have to provide economic stimulus in the form of higher spending and greater aid to those in distress — and the stimulus plan won’t come soon enough or be strong enough unless politicians and economic officials are able to transcend several conventional prejudices.

One of these prejudices is the fear of red ink. In normal times, it’s good to worry about the budget deficit — and fiscal responsibility is a virtue we’ll need to relearn as soon as this crisis is past. When depression economics prevails, however, this virtue becomes a vice. F.D.R.’s premature attempt to balance the budget in 1937 almost destroyed the New Deal.

Another prejudice is the belief that policy should move cautiously. In normal times, this makes sense: you shouldn’t make big changes in policy until it’s clear they’re needed. Under current conditions, however, caution is risky, because big changes for the worse are already happening, and any delay in acting raises the chance of a deeper economic disaster. The policy response should be as well-crafted as possible, but time is of the essence.

Finally, in normal times modesty and prudence in policy goals are good things. Under current conditions, however, it’s much better to err on the side of doing too much than on the side of doing too little. The risk, if the stimulus plan turns out to be more than needed, is that the economy might overheat, leading to inflation — but the Federal Reserve can always head off that threat by raising interest rates. On the other hand, if the stimulus plan is too small there’s nothing the Fed can do to make up for the shortfall. So when depression economics prevails, prudence is folly.

The arguments against bold action all come down to a single idea. Normally it is better - safer - to be prudent, cautious and careful because the risks of error become much larger when taking bold action. Conservatives will feel more secure taking this course. But as Krugman says, conditions are now not normal. We are now in Depression economics where normal economics no longer work.

Now the biggest risks are in NOT acting boldly.