The Return of Depression Economics combines Krugman’s narrative with his analysis of the significant economic recessions of the past century, culminating to the crisis of 2008. Krugman assesses the crises in the United States of the early 1900’s and the crises in Asia and Latin America of the 1990’s, before perceptively demonstrating their similarities to the Great Recession. He observes that we did not learn from our mistakes during the crises of the 20th century and, inevitably, we suffered the consequences in 2008.
The Return of Depression Economics can make you envious of Krugman’s eloquence at times: he has a knack of being able to express economic concepts in the simplest of forms. In this instance, he illustrates recessions through a model of a congressional babysitting group in Washington DC: there was a currency of coupons that entitled the bearer to one hour of babysitting. However, parents would begin to hoard coupons for the future, causing the number of coupons in circulation to fall. It got to the point where parents who felt their reserves of coupons to be insufficient were anxious to babysit and were reluctant to go out, hence there was a recession. Krugman repeatedly refers to this model in the context of other crises, adapting it to better match the circumstances.
In particular, there is an aspect in this model that Krugman refers to time and time again: anxiety – which is otherwise expressed, in economic terms, as confidence. Krugman stresses how confidence not only instigated but deepened recessions, particularly the currency runs of the 1990’s, to the extent that he believes, “within limits, the expectations, even the prejudices of investors, become economic fundamentals.” He goes on to describe a “circle of financial crises,” where a loss of confidence leads to a plunging currency, rising interest rates and a slumping economy, leading to financial problems for firms, banks and households, resulting in a further loss of confidence, and so on.
However, even though economists were aware that such a circle existed, the disastrous effects of the currency runs of the 1990’s came as a great surprise. Krugman explains that this is because no-one quite anticipated the strength of the feedback process, which, as he puts it, is like the feedback loop of a microphone in an auditorium: “sounds picked up by the microphone are amplified by the loudspeakers; the output from the speakers is itself picked up by the microphone.” If the auditorium is echoey, any little sound is picked up, amplified and picked up again to create a deafening screech.”
Krugman’s insistence that confidence is a significant cause of recessions forms the basis for his belief that governments should have a greater role in the financial system. Intervention and regulation, as he believes, prevents confidence from growing too rapidly or falling too dramatically, allowing crises to be averted in the first place.
Krugman’s conclusion is that, in modern times when depression economics takes precedence, there is a “free lunch” as idle resources can be put back into use – “true scarcity in Keynes’ world … was not of resources, or even virtue but of understanding,” as he explains. His polemic is that our economic problems are not structural; “the only important structural obstacles are the obsolete doctrines that clutter the minds of men.”
This is all very well but, throughout the book, Krugman implies that, when there is a free lunch, you should be suspicious. A particular example of a free lunch that he describes are auction-rate securities, which offered people a better deal than conventional banking, that went on to collapse in 2008 and contributed to the crisis. I do not question Krugman’s knowledge – he’s an exceptional economist – but I am suspicious of the fact that his own doctrines, that help to prevent crises and revive economies, offer us the very thing that may cause crises in the first place.
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