Friday, January 2, 2009

Krugman on the Crash of 2008

Paul Krugman, The Return of Depression Economics and the Crash of 2008. Norton, 1999, 2009.

This book is a very substantial revision of a 1999 volume called The Return of Depressions Economics. The title was meant to shock in 1999. Financial crises like Thailand's or deep persistent slumps like Japan's -- they couldn't happen here, could they? Krugman wanted to wake up policy makers to the fragility of the financial system and the idea that financial crisis could lead to depression-style economic crisis. No one will be shocked by the title today, ten years later.

I have used this book in my classes continuously since it was first published, although my spin on it has evolved as economic conditions have changed. Krugman's revision is pretty much in line with the way I taught this material last semester. I take this to mean that I have not entirely misread the world has we have moved towards this point, although I obviously do not claim Krugman's expertise. Or maybe we both misread it the same way. Time will tell.

Not everyone will be happy with the way the book is organized. Krugman saves his analysis of the current crisis until the final chapters and I think many readers will want to see this material earlier. But I am on Krugman's side. It seems to me that you really do need to understand the financial crises of the last twenty years in order to appreciate our current situation. Those who don't understand history are doomed to repeat it, they say. The crises in Japan, Mexico, Thailand, Hong Kong, Russia and Argentina give Krugman an opportunity to introduce key theories and concepts in a real world context that is highly relevant to the final analysis.

Not everyone will like the end of the book, either, where Krugman provides policy recommendation. Many readers will be looking for very detailed proposals from the most recent Nobel winner instead of broad outlines, but is that fair to ask? Events move too quickly now; the situation is so fluid. Krugman's three-part plan (large-scale capital infusions to stop the financial crisis, large-scale fiscal stimulus to end the economic slump, reformed financial regulation to extend bank-type controls to bank-like institutions) makes sense now and will probably be seen to make sense when we look back upon them in ten years.

One thing that I missed was a fuller discussion of capital controls. Krugman talked in more detail about controls on destabilizing hot money movements in the earlier volume and comes very close to endorsing them here, at least in emergency situations. But he doesn't really make the case. You can't please everyone, I guess.

There are many good moments in the book, including the analysis of the Greenspan years and the housing bubble and the discussion of hedge funds and the rise of unregulated non-bank banks. And there was one scary moment for me. Reading the first paragraph of the last chapter I immediately recognized the words. Where had I read them before? "The world economy is not in depression; it probably won't fall into depression ..." (my emphasis added).

Oh, yes. They are exactly the same words he in this same place in the book used ten years ago.

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