The Return of Depression Economics, by Paul Krugman
Paul Krugman, professor and writer for the New York Times, wrote this book in the late nineties, about the Latin American, Japanese and broader Asian financial crises of that decade. But it's obvious, I think, why I picked it up right now, as Bear Stearns and Northern Rock are worth a fraction of their earlier selves, as the Fed pumps money into the American banking system, as the interest rates paid by British borrowers diverge from those set by the Bank of England and property prices both sides of the Atlantic are shrinking. I'm not one of those armchair economists who think we're about the repeat the Great Depression. To that extent, I agree with David Smith. But nor am I one of the many, many British Polyannas who've been hoodwinked by the Brown boom of the last ten years into thinking that recessions are old hat (having been replaced by more fashionable "slowdowns") and house prices never go down. I'm a pretty gloomy armchair economist, then - and I do think the UK at least is headed for a big fall in house prices, at least, even if the likely recession is a mild one. But, back to the real economist and his book.
It's not a bad read: the pages turn quite quickly considering it's about finance. And Krugman illustrates his argument well, needlessly defending his use of a brilliantly illuminating model of a baby-sitting cooperative to illustrate how demand can shrink and make recessions happen, and how deliberate inflation can cure them. Once or twice his habit of launching a new section with a jolly-sounding anecdote or scene grates on the British reader - why is that style so loved by American writers and publishers? - but if you're like me you'll forgive an interesting expert on an important subject where you wouldn't forgive, say, a self-help or management theorist.
Krugman's argument has a number of strands. That the business cycle is not dead; that mainly rightward-leaning economic orthodoxy of the last twenty years or so has wrongly neglected the important role of aggregate demand in the economy, believing that flexible supply-side policies towards business and labour were enough to ward off recessions; that old-fashioned Keynesian remedies - public spending, cutting taxes, lowering interest rates - still have a very important role to play; that structural reforms and tight fiscal regimes imposed on developing countries essentially by Washington have intensified or even caused financial crises in those countries; and that a good dose of inflation may be the best way to prevent or recover from recession caused by a financial liquidity crisis.
It's persuasive, although for the non-economist reader I think he'd have done better to summarise at some point the key lessons he draws from his study of these economic crises, and how they hang together as a coherent approach to policy. What's most interesting is the way he foresees the risk to the entire developed world of a strictly financial liquidity crisis, caused by innovative investment practices - he explains the way hedge-fund speculators caused havoc in Japan and Hong Kong by shorting stocks in just the way HBOS was recently undermined by short selling in London.
The hedge-fund scare revealed that modern financial markets, by creating many institutions that perform bank-like functions but do not benefit from bank-type safety nets, have in effect reinvented the possibility of traditional financial panics. Let's try to figure out who owes what to whom, and build some new firewalls, before crisis hits again.
He argues that swift, decisive action is needed in such circumstances, to inject liquidity and prevent a downward demand cycle, Depression-style - and that worries about inflation should be put aside. Ben Bernanke, a student of the Great Depression, seems to be following something like that approach in the United States; I'm less sure that Mervyn King's instincts at the Bank of England are the same as Krugman's. And of course Alistair Darling has just been unable to fiscally inject the UK economy.
I'm not sure Krugman has all the answers, but this is key reading for our times.
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