The Coming Third Depression

Depressions don’t come along too often, economist Paul Krugman — 2008 recipient of the Nobel Prize in Economics — wrote in a June 28th, 2010 op-ed column, but for his money, we’re in the early stages of a “third depression” right now, and bad policy is to blame. Krugman argues that policy-makers have taken a very wrong turn over the past few months by pushing for austerity measures when they should be pumping money into struggling economies — current sovereign deficits be damned. The newly popular, faulty logic was on display at the G-20 summit, Krugman complains, when officials were “obsessing about inflation, when the real threat is deflation; preaching the need for belt-tightening, when the real problem is inadequate spending.” While hard-liners point to the supposed EU budget crisis and the large U.S. debt to justify cuts, Krugman says that this focus misses the point and ensures a long-term Re/Depression, a decade of long-term unemployment, rising social safety net costs, dramatically lower tax revenue, and skyrocketing sovereign deficits.

The Third Depression

By PAUL KRUGMAN

Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.

Neither the Long Depression of the 19th century nor the Great Depression of the 20th was an era of nonstop decline — on the contrary, both included periods when the economy grew. But these episodes of improvement were never enough to undo the damage from the initial slump, and were followed by relapses.

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation, when the real threat is deflation; preaching the need for belt-tightening, when the real problem is inadequate spending.

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.

But future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style 1990’s deflationary traps [Do most Americans even know about Japan’s “Lost Decade?” Doubtful].

In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of tight-money and balanced-budget orthodoxy.

As far as rhetoric is concerned, the revival of the old-time religion is most evident in Europe, where officials seem to be getting their talking points from the collected speeches of Herbert Hoover, up to and including the claim that raising taxes and cutting spending will actually expand the economy, by improving business confidence [You know, today’s conservative and republican argument in the U.S.]. As a practical matter, however, America isn’t doing much better. The Fed seems aware of the deflationary risks — but what it proposes to do about these risks is, well, nothing. The Obama administration understands the dangers of premature fiscal austerity — but because republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.

Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions [But, what’s the big deal about these minor blemishes? Has anyone taken note of California — our Crucible?]. And it’s true that bond investors have turned on governments with intractable deficits [Forget about these emotional wrecks… They hate you if your deficits grow… They hate you if you cut off the spigot keeping markets moving]. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the world’s policy makers seemingly don’t understand that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.

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