38 • Trade Insight • Vol.5, No.2, 2009

book reviewbook review

Depression economics is backand is more relevant than ever

to ensure that the gains in prosperi-ty achieved in the past several de-cades do not evaporate in a fewmonths. Countering Robert Lucas’sclaim at an American Economic As-sociation presidential lecture in 2003that the “central problem of depres-sion-prevention has been solved forall practical purposes", Paul Krug-man, the 2008 Nobel Laureate in eco-nomics, argues that the problem isfar from being solved.

In The Return of Depression Eco-nomics and the Crisis of 2008, the Prin-ceton University professor contendsthat economists and policy makersignored warnings about bubblingsectors and believed in “a set of fool-ish ideas” and “crank doctrine” likesupply-side economics that only ap-pealed to editors and wealthy menwho succumbed to the flawed ideol-ogy. Rightly invoking John MaynardKeynes’s ideas and relating them tothe crises since the 1930s, Krugmanshows that depression economics,which is “the study of situationswhere there is free lunch becausethere are unemployed resources thatcould be put to work", is still rele-vant and we are far from fully fath-oming business cycles.

In 10 chapters covering the ideo-logical battle, the crises in Japan,East Asia and Latin America, thebubbles created by Alan Greenspanwhile at the helm of the United States(US) Federal Reserve, the shadow(parallel) banking system and thepresent crisis, Krugman offers a com-pelling case for the relevance of Key-nesian economics and the need tostimulate aggregate demand and re-store market confidence, by all pos-sible means (even short-term nation-alization of banks and more govern-ment spending than tax cuts), whenthe economy is in a deep financialslump and a liquidity trap. He lu-cidly explains the persistent slump

Return of depression economics

in the Japanese economy—which hesays is a classic case of liquidity trapand bears a striking resemblance tothe present economic crisis—and thewaves of currency crises, from thetequila crisis in 1994 to the EastAsian crisis in 1997.

Perhaps the most important pointis Krugman’s emphasis on the factthat warnings about bubbles weremissed (or ignored) and it is entirelypossible to have an economic crisis,triggered by a crisis of confidence,even in a stable market economy.Even the most promising economieswere vulnerable to self-fulfilling pan-ics. Krugman argues that the policyresponse to big crises was not enoughin the crisis affected countries. Heargues that Japan failed to act quick-ly and decisively in restoring marketconfidence and recapitalizing thebanking system. While the crisis wasbrewing since 1990, it was only in1998 that Japan’s legislature passeda US$500 billion bank rescue plan.Similarly, Mexico failed to devalueits currency enough to avoid fertileplaying field for speculators and en-gaged in irresponsible politics thatfurther disturbed investor’s confi-dence. He believes that the current

fiscal rescue package in the US(around 1 percent of gross domesticproduct) is short of the expenditurerequired to stimulate demand in arecession of this severity and magni-tude—a point contested by conser-vative economists and policy mak-ers. He also comes down heavily oninvestors like George Soros, the In-ternational Monetary Fund (IMF)and the US Treasury for fuelling cri-ses and advocating counterproduc-tive policies during distressed times.

Krugman argues that to get out ofa slump, it is necessary to heat up aneconomy, even by excessive govern-ment spending, i.e., it is okay to havemoderate inflation. Krugman’s crit-ics disagree, arguing that exclusive-ly focusing on “Keynesian compact”would leave the economy vulnera-ble to disturbances in aggregate sup-ply caused by expectations of infla-tion. However, this should be of asecondary concern at a time whenthe credit market is frozen, produc-ers are closing factories, consumersare not spending, and there are un-used resources that could be proper-ly put to work.

There are talks about a secondstimulus package in the US (Krug-man wants it to be 4 percent of grossdomestic product). Along with othercountries, China, Japan, India, andthe European Union are spendingbillions of dollars to stimulate theireconomies. And, the IMF is armedwith US$500 billion to stimulate de-veloping economies. The world haslistened to Krugman’s call for resort-ing to the good “old Keynesian fis-cal stimulus”. The tide is on Krug-man’s side. Only time will tell howstrong the tide will be in pulling theglobal economy out of the recession.

The author is based in Washington, D.C.,and has recently been appointed as Jun-ior Fellow for Trade, Equity and Devel-opment Programme at Carnegie Endow-ment for International Peace.

Title: The Return of DepressionEconomics and the Crisis of 2008

Author: Paul Krugman

Publisher: W.W. Norton & Company, 2009

ISBN: 978-0-393-07101-6 (hardcover)

Chandan Sapkota