The Return of Depression Economics and the Crisis of 2008


Filed Under : Federal Reserve, Inflation

Reading The Return of Depression Economics, I have to admit I was surprised. Paul Krugman, 2008 Nobel Prize winner in economics and New York Times columnist, isn’t as feisty and partisan in the book as he is in his column. Moreover, he presents some useful information about the many economic collapses that have occurred in the past 20 years.

But, alas, in the end Krugman resorts to the arguments of the great economic cranks of history, from Silvio Gesell to John Maynard Keynes. He’s like the mechanic who expertly describes a problem with your fuel pump—then insists your car needs more gas. If the tank is full, he tells you to attach an auxiliary tank.

In other words, Krugman is still the one-trick pony featured in the Times. Whatever the problem, his solution is always the same: inflation. It shows up in the example he uses throughout the book, a 1970s babysitting co-op on Capitol Hill.

The baby-sitting “economy” is a co-op in which the couples agree to babysit one another’s children for coupons (babysitting credits) instead of dollars. But Krugman says this scheme ran into problems during the winter. The couples hoarded their coupons (that is, they refused to hire babysitters) while trying to get more coupons (sell babysitting services) so they would be able to go out more often in the summer.

Unfortunately, with everyone pursuing the same strategy at once—trying to sell without buying—Krugman writes, the co-op went “into a recession.” But never fear: This babysitting “liquidity trap” ended when the directors of the co-op printed and distributed more coupons and everyone lived happily ever after.

The problem with drawing general lessons from this situation should be obvious. A babysitting co-op in which a few people with similar preferences produce one good cannot be a model for a complex economy. But since Krugman—like other Keynesians—believes an economy is a crude, simple mechanism controlled by “aggregate demand,” this is the best he can do.

Writing about this “fix” for the co-op, Krugman says, “Recessions, in other words, can be fought simply by printing money—and can sometimes (usually) be cured with surprising ease.”

Even though I have read many of Krugman’s columns and was not surprised by this answer, it is nonetheless shocking to read that a Nobel laureate actually believes that we can “cure” almost any economic downturn by cranking up the printing presses.

That’s bad enough, but Krugman also likes to rewrite economic history.

He says our present economic and financial troubles are due to free markets and financial deregulation. He argues that the cartelized financial system created during the New Deal should have remained unchanged, even though it was actually in crisis back in 1980. The alleged “deregulation,” however, did not create free markets but expanded moral hazard by increasing deposit insurance and empowering the Fed to “backstop” financial market losses, which invited reckless behavior on Wall Street. All this federal interference with both free markets and an authentic profit-and-loss system resulted, predictably if sadly, in the current financial meltdown.

From blaming the Great Depression in part on the gold standard to caricaturing free markets, Krugman places himself squarely in the socialist-interventionist camp. He writes: “Some people say that our economic problems are structural, with no quick cure available; but I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men.” Unfortunately Krugman counts freedom among them.


December 2009

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December 2014

Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.
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