In 1999, economist Paul Krugman wrote a book entitled "The Return of Depression Economics," which examined the string of economic crises that plagued nations spanning from Asia to Latin America during that decade. Nine years later, "depression economics" have evidently returned once again, this time to America. And so Krugman has also returned, armed with an expanded and updated edition of his book, now known as "The Return of Depression Economics and the Crisis of 2008".
Depression economics, according to Krugman, are "a state of affairs like that of the 1930s in which the usual tools of economic policy -- above all, the Federal Reserve's ability to pump up the economy by cutting interest rates -- have lost all traction. When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly." In his new book, which arrived in stores this week, he explores the inflating, and bursting, of the housing bubble, the failure to regulate the "shadow banks," how financial globalization may make a global economic slump all the more likely, and, most importantly, what needs to be done to combat the current crisis.
Krugman, who teaches at Princeton and is a columnist for the New York Times, received the Nobel Prize in economics in October. The Huffington Post recently corresponded with him via email about the stimulus plan he hopes Obama implements, whether he'd ever work for the government, and if the business cycle can ever be overcome.
Huffington Post: When did you realize that what you call "depression economics" had truly returned?
Paul Krugman: I think it was early October -- a short time after the fall of Lehman, when it became clear that total panic had set in.
Despite the return of depression economics, you say that we are most likely not heading into a depression, but also that you are not as sure as you'd like to be about your claim. Has anything happened in the last few weeks to make you less sure?
Yes -- the numbers on the real economy, stuff like retail sales, industrial production, imports, exports, have been coming in even worse than I expected. So right now it looks as if the economy is really falling off a cliff. This makes me less sure than I was that even strong support measures will pull us out of the dive.
While some on the left want to blame deregulation for the current crisis, you argue that at the core of the crisis is the "shadow banking system" that was never regulated at all. Were there opportunities to enact greater regulation that were missed?
There was an opportunity to regulate derivatives, which might have helped. There were also moves to crack down on subprime lending, blocked by the Bush administration, that might have helped. But basically I'd say that the spirit of the times was so anti-regulation that very few people even thought about policing shadow banking.
Does that mean that, in retrospect, its collapse was fairly inevitable?
Yes. If the housing bubble hadn't done it, something else would.
You've written that FDR was at times too cautious in his response to the Great Depression, and that by reducing spending and raising taxes in 1937 to appease deficit hawks he sent the economy into a severe recession. Do you think the next administration recognizes that they should err heavily on the side of too much stimulus?
I think they understand that they have to go big; what I don't know is whether they understand just how big big is. But they are being bombarded with concerns, not just from me but from a lot of people, and unlike the current administration they actually listen to experts. So I'm hopeful that they'll do the right thing.
How big is big? You've mentioned a $600 billion stimulus: what would it consist of?
Around $350 billion in infrastructure, I think -- that's a rough estimate of the amount that could be started quickly. The rest would consist of aid to the unemployed, aid to state and local governments, expanded Medicaid benefits, and probably a limited set of tax rebates.
Do you feel confident that Obama will deliver on something that bold?
I'm hopeful -- I wouldn't quite say confident.
Have you ever given any thought to following the path of your former Princeton colleague Ben Bernanke and serving in the government?
Yes, I've thought about it, and decided it was a bad idea. I'm temperamentally unsuited, and probably have as much influence on policy from my current perch as I would from inside the government.
It seems some conservatives continue to take the opposite position on FDR, that he actually made the Depression worse by doing too much, as opposed to too little. Do you see conservative ideology as presenting a real challenge in terms of pushing through an ambitious public spending program?
I do worry that a coalition of Republicans and Blue Dogs will block some needed measures, and that policy will be too cautious. I'm less worried that the "FDR made the Depression worse" people will have much influence -- they may get lots of Wall Street Journal ink, but they're pretty discredited.
Was the Treasury's plan to unlock the credit markets by lending to consumers the right move?
Maybe. Basically, policy just has to keep going wider, until the credit markets unfreeze. If that temporarily means that Treasury is getting into the consumer lending business, okay.
How wide do you think they'll have to go?
I think we're going to see partial nationalization of banking. That includes treating Fannie and Freddie as the nationalized lenders they are, and probably taking an actual controlling interest in some financial institutions -- the way we already have in AIG. And then using that control to ease credit for ordinary Americans.
Could a lack of action over the next two months ultimately prove fatal to our chances for a timely recovery?
Fatal I don't know. But these are two bad months to have policy comatose.
If you were Henry Paulson, would you be concerned about the amount of attention on the Treasury right now? Is there such a thing as too much transparency?
There are some subtle reasons for being obscure, sometimes -- there are situations in which, say, loans to banks are best kept unannounced, because there may be a stigma attached. But by and large the more transparent the better. And it's not just about economic policy: after eight years of secretive government that ignored the rule of law, sunshine is an important principle.
You've written that were the Big Three to fall it would cause massive job losses. But bigger picture, would it stop there, or would it export a great deal of financial power?
I don't know about the financial power issue; when a country is as big as America, I don't worry about a bit more foreign ownership. But I just find the thought of a major auto failure in the middle of an economic nosedive terrifying.
What would the consequences of failure be?
One to three million jobs lost, perhaps permanently, at the worst possible moment.
Your colleague Tom Friedman told us in a recent interview that he thought President Bush was leaving two deficits -- an economic deficit and a climate deficit. Do you think they can both be addressed early in an Obama administration?
Honestly, climate will be hard to do early. It will impose economic costs at first, and the middle of a deep slump may not be politically the easiest time to sell tough measures. I'd vote for health care first, saving the planet later.
You talk in your book about people who believed, incorrectly, that the business cycle of boom and bust was over. Can the business cycle ever be conquered?
The cycle can be mitigated, not eliminated. Believing that it's gone is a good way to set yourself up for a bigger bust -- and that's what just happened.