Review Of Return Of Depression Economics_trade Insight_vol5no2_sawtee

book review book review

Return of depression economics Chandan Sapkota

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epression economics is back and is more relevant than ever to ensure that the gains in prosperity achieved in the past several decades do not evaporate in a few months. Countering Robert Lucas’s claim at an American Economic Association presidential lecture in 2003 that the “central problem of depression-prevention has been solved for all practical purposes", Paul Krugman, the 2008 Nobel Laureate in economics, argues that the problem is far from being solved. In The Return of Depression Economics and the Crisis of 2008, the Princeton University professor contends that economists and policy makers ignored warnings about bubbling sectors and believed in “a set of foolish ideas” and “crank doctrine” like supply-side economics that only appealed to editors and wealthy men who succumbed to the flawed ideology. Rightly invoking John Maynard Keynes’s ideas and relating them to the crises since the 1930s, Krugman shows that depression economics, which is “the study of situations where there is free lunch because there are unemployed resources that could be put to work", is still relevant and we are far from fully fathoming business cycles. In 10 chapters covering the ideological battle, the crises in Japan, East Asia and Latin America, the bubbles created by Alan Greenspan while at the helm of the United States (US) Federal Reserve, the shadow (parallel) banking system and the present crisis, Krugman offers a compelling case for the relevance of Keynesian economics and the need to stimulate aggregate demand and restore market confidence, by all possible means (even short-term nationalization of banks and more government spending than tax cuts), when the economy is in a deep financial slump and a liquidity trap. He lucidly explains the persistent slump

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• Trade Insight • Vol.5, No.2, 2009

Title: The Return of Depression Economics and the Crisis of 2008 Author: Paul Krugman Publisher: W.W. Norton & Company, 2009 ISBN: 978-0-393-07101-6 (hardcover)

in the Japanese economy—which he says is a classic case of liquidity trap and bears a striking resemblance to the present economic crisis—and the waves of currency crises, from the tequila crisis in 1994 to the East Asian crisis in 1997. Perhaps the most important point is Krugman’s emphasis on the fact that warnings about bubbles were missed (or ignored) and it is entirely possible to have an economic crisis, triggered by a crisis of confidence, even in a stable market economy. Even the most promising economies were vulnerable to self-fulfilling panics. Krugman argues that the policy response to big crises was not enough in the crisis affected countries. He argues that Japan failed to act quickly and decisively in restoring market confidence and recapitalizing the banking system. While the crisis was brewing since 1990, it was only in 1998 that Japan’s legislature passed a US$500 billion bank rescue plan. Similarly, Mexico failed to devalue its currency enough to avoid fertile playing field for speculators and engaged in irresponsible politics that further disturbed investor’s confidence. He believes that the current

fiscal rescue package in the US (around 1 percent of gross domestic product) is short of the expenditure required to stimulate demand in a recession of this severity and magnitude—a point contested by conservative economists and policy makers. He also comes down heavily on investors like George Soros, the International Monetary Fund (IMF) and the US Treasury for fuelling crises and advocating counterproductive policies during distressed times. Krugman argues that to get out of a slump, it is necessary to heat up an economy, even by excessive government spending, i.e., it is okay to have moderate inflation. Krugman’s critics disagree, arguing that exclusively focusing on “Keynesian compact” would leave the economy vulnerable to disturbances in aggregate supply caused by expectations of inflation. However, this should be of a secondary concern at a time when the credit market is frozen, producers are closing factories, consumers are not spending, and there are unused resources that could be properly put to work. There are talks about a second stimulus package in the US (Krugman wants it to be 4 percent of gross domestic product). Along with other countries, China, Japan, India, and the European Union are spending billions of dollars to stimulate their economies. And, the IMF is armed with US$500 billion to stimulate developing economies. The world has listened to Krugman’s call for resorting to the good “old Keynesian fiscal stimulus”. The tide is on Krugman’s side. Only time will tell how strong the tide will be in pulling the global economy out of the recession. The author is based in Washington, D.C., and has recently been appointed as Junior Fellow for Trade, Equity and Development Programme at Carnegie Endowment for International Peace.