Review of The Return of Depression Economics and the Crisis of 2008 (Hardcover)

Depression economics is when conventional economic wisdom no longer applies.In a "normal" recession the Federal Reserve would lower interest rates in order to stimulate consumption and investment.According to Paul Krugman, that remedy is no longer getting any traction.He claims it's time to cast conventional economic wisdom to the wind.The economy is in such a deep hole that he's calling for another $600 billion in federal outlays.This is in addition to the $700 billion already asked for by Treasury Secretary Paulson, and looks very similar to Obama's spending plans for next year.

This is a re-issue of a book written by Krugman in 1999 after multiple economic crises in the decade of the 1990s.Japan had just lost a decade's worth of growth for responding too timidly to the bursting of their stock and real estate bubbles.Krugman also analyzes the various currency crises of that decade: from Britain and Sweden in the early 90s, to Mexico and Argentina in the mid-90s, and finally to Brazil and East Asia in the late 90s.These crises occurred as globalization was doing its work in the currency markets.

In his analysis of Japan's lost decade, he argues that everything must be done to increase aggregate demand.The collapse of demand caused by loss of confidence and fear had severely depressed spending and investment.At that point only government spending can lessen the severity of the recession and perhaps even turn the economy around.In Krugman's view, the lackluster response was the reason it took Japan so long to recover.He believes that one should only worry about deficits and debt when the economy is on the rebound.(This is completely contrary to what Robert Samuelson advises in The Great Inflation and Its Aftermath: The Past and Future of American Affluence.)

Krugman claims that the financial crises of 2008 is "functionally similar" to the Great Depression.He does not believe, however, that it will be as severe.We now have the financial tools and institutions - and the hindsight - to make for a softer landing.Nevertheless, this crisis has no end in sight yet.The one big thing that everyone seems to know now is that one does not increase taxes and implement budget cuts during a crisis, as Herbert Hoover did.And which FDR did several years into the Depression.

Another lesson that Krugman derives from the 90's is the need for greater regulation.As one country after another experienced currency problems from investor flight, there was one country that did better than others to weather the storm: that country was Malaysia.It's leader Mahathir Muhammed was of the same mind as Krugman.Managing the capital flows in and out of the country will soften the blows, should foreign investors decide to pull out.The conventional wisdom of the time was that price stability and currency convertibilty were the only things needed, and that the market would take care of the rest.However, in this case, a little more regulation saved them from a crisis.

Depression economics goes against the grain of conventional economic wisdom, and given the current crisis it is coming back into fashion, even among those who preached deregulation and fiscal restraint a decade ago.This theory should be applied sparringly, only in extreme cases - the present crisis probably qualifies.It should not be applied to every minor recession that comes along.The danger of overuse of depression economics is that it can cause a toxic brew of inflation and stagnation - not to mention corruption.



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