Let's hope Krugman is wrong this time. He has generally been much more correct than the conventional widsom from the business school and conservative economists. For instance he called it correctly that the anemic stimulus package loaded with additional tax breaks for the wealthywould not be sufficient. *********** Op-Ed Columnist The Third Depression By PAUL KRUGMAN Published: June 27, 2010 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 deflationary traps. 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 hard-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. 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. And it’s true that bond investors have turned on governments with intractable deficits. 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 financial markets understand what policy makers seemingly don’t: 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. http://www.nytimes.com/2010/06/28/opinion/28krugman.html?hp
It's not really clear if he was right or not. The ideal goal of the stimulus is to turn the economy around without making it dependent on government going forward. The stimulus definitely had a positive impact in turning the economy around - it's now growing, though slowly. Whether it will be sustainable is unclear. Whether more spending would have made it more sustainable is also unclear. We may get some of these answers soon - though it may also be one of those things where we never know because we don't know the result of the alternative scenario. All that said, what he talks about here is definitely of a concern. Pulling stimulus too early is a very real danger.
Yes, I have a feeling this isn't gonna turn around any time soon. The ones with power would have to be removed and the culture of business would have too change. The powerful will never leave willingly and will continue to feed us BS.
It seems like he is really downplaying what is happening to Greece and the potential threat to the Euro. I'm not sure that can easily dismissed and continued deficit spending does have a implications in regard to price stability and markets.
Maybe he's downplaying Greece to soften the notion of bailing out states like California. The unemployment benefit extension that didn't pass is driving a budget knife into state governments.
Greece is a bit unique though (as is the Euro) - they can't finance their own debt by printing money. If Greece was on its own currency, it could fix its problems much more easily by simply inflating its way out of its mess.
IIRC Krugman has been sceptical about whether the Euro would work as a currency and would probalby advocate that Greece abandon the Euro and devalue its currency. Krugman believes deficits matter in the law run, but a major recessio or depression is no time to worry about balancing budgets and controlling needed government spending.
The U.S. isn't Greece. And the Federal Gov't needs to get that $8k tax credit back in action as well as extend unemployment benefits. Our deficit is atrocious but that's the price we paid for running one in boom times. You can't raise taxes now, and you can't cut spending. We need more stimulus. Anything to continue the housing market from collapsing, keep consumer spending up, and keep businesses producing should be done. Eventually things will right itself but it takes time for an economy to build momentum. We were starting to but now things have stalled because of the end of the tax credit plus the crisis in Europe. Not a good time to play politics.
The stimulus wasn't big enough or fiscal stimulus just isn't that effective? I guess it's a matter of perspective (or ideology). I agree with Krugman, though, that we need more aggressive monetary policy.
I disagree on the homebuyer tax credit. It served an interesting and unique purpose when the housing market had the threat of freefall due to the financial collapse. But more recently, it was just a crutch. Whenever it ended - last month or a year from now, it was going to cause a huge dislocation in the market because houses would suddenly be $8k more expensive overnight (on a side note, I do think they should have fazed it out from $8k to $7k to $6k etc each month to prevent that dislocation - I can't fathom why they thought an immediate end to it was a good idea). But ultimately, given our fiscal problems, every dollar spent should have an eye to maximum impact, and that tax credit has very little multiplier effect. I'd much rather that money go directly to infrastructure building or something that has maximum job creation & multiplier effects.
I thought we were supposed to go on a massive spending spree and create a bunch of jobs for upgrading our infrastructure (roads, bridges, etc.)?
^That's considered Phase 2, but states are siphoning off those funds to pay off their own crushing budget.
I completely disagree. For the housing market to recover - all that excess inventory has to go - so you got to get people to buy it up so developers start the machine back in motion...you can't let the economic pistons stutter or the whole engine stalls and loses speed. The keys to a growing economy are consumer spending, housing starts, and manufacturing. Why? because all three employ people which leads to increase disposible income which leads to more spending, housing starts and manufacturing which leads to more jobs and so on and so forth. That's your multiplier effects. Basically, the stimulus is meant to jump-start a heart that's stopped beating. What you are proposing in cutting off these kinds of stimulus is like saying, since the patient can't survive without a heart lung machine, we might as well cut it off and let the patient die. No use unless you can apply the cure right now. No...don't let the economy collapse...do whatever it takes to prop it up until it can hold it's own without the stimulus. Let job growth occur. Since the tax credit and employment benefits have ceased, the dow has started crashing again and the economy is once again tanking.
I'm suggesting that the stimulus doesn't really fix that problem. Giving people $8k in a tax credit doesn't stimulate the housing market anymore - it just artificially props up prices. What needs to happen first is for prices to permanently stabilize, and for that to happen, you have to take out the artificial side of it. Take out the tax credit - prices will drop and that will stimulate demand. For the past year, the entire market has been artificial - that's not sustainable. The stimulus was necessary in late 2008 / early 2009 when the economy was falling off a cliff - and it helped stabilize the housing market which helped prevent the banks from failing, which prevented a whole additional leg down. Now the housing market has to function on it's own. Part of the problem is that there are not enough people for the number of houses out there because of all the speculative construction from the last decade. If you really want to stimulate housing construction, you have two options: turn renters into buyers or reduce the supply. The best way to turn renters into buyers is to lower the overall prices. The much cheaper solution is to start tearing down old / decrepit housing. You solve the inventory glut and get rid of the lowest quality junk at the same time, so when construction does start, you have better quality housing out there. The market started crashing long before unemployment benefits ceased. It did start shortly after the tax credit expired, but long before any effects from that credit were lost (early May). The market is crashing for entirely different reasons, primarily centered around a European collapse and concerns in China, as well as a questionable US employment number. None of these things were caused by the expiration of the tax credit or unemployment benefits.
I just think it's a very dangerous strategy to pull stimulus out of a weak economy. The stimulus basically had saved us from a global economic depression in which many more people would have lost jobs, suffered foreclosures and led to dangerous levels of unemployment. The stimulus is holding things up against collapse. If it collapses, it can be very bad as there are negative multipliers. We are not out of the woods yet. Especially with the uncertainty globally. The tax credit is what is helping Americans buy property which in turn allows develops to start building again. Tearing down old properties doesn't help my friend. It doesn't create value, that actually only makes properties more expensive for everyone and can actually make things worse since it will slow down sales as prices are driven up. You don't want housing prices to go up necessarily, you want housing starts to go up. And that happens when people buy homes. Yes, developers will look to build in neighborhoods where they can get the most money. But if there is a market, they builders will adjust to build the homes that will sell in that market. So prices isn't key. But if the developers money is caught up in unsold buildings, that's not going to lead to new housing starts. The only way you get that is by incentive people to buy new constructions so developers can reinvest money into new projects.
What do you guys think of bulldozing vacant homes to reduce excess supply? Sounds doable in theory, but I doubt it's realistic.
It's happening in Flint and Detroit has a plan to do it. I think it makes sense if the cost of keeping up vacant homes is more than they are worth.
Housing is an incredibly vital component as housing declines equal mark down of leveraged pools of MBS and CDO's and widening of credit default swaps which adversely affects virtually all banks in the world. When banks are adversely affected, they don't lend. Lending is the lifeblood of our economy, and companies hoard cash when they don't have faith in the financial system to get access to credit if needed. This causes unemployment to jump (or stay high) and limits consumer spending which is over 70% of GDP so its a big recession factor. I think Krugman has a solid point regarding reigning in spending at this fragile state of the economy, but his political motiviations also lean him towards this idea as high inflation bails out the debt-ridden at the expense of the savers (those with assets/wealthy) which normalizes wealth in society which is a big social concern of his.
So, I guess the best course of action is to give incentives to try and push people who aren't sure if they can afford homes to go ahead and make the jump! ...I think I've heard this one before. Even with stimulus, I just don't see how home prices are sustainable over the long term. Decline in speculation, the end of booming home values for possibly decades, high unemployment, much tighter lending standards...who is going to buy these houses at these still-inflated prices? If they're doing it primarily because they're getting a measly $8k tax credit, they probably shouldn't be buying in the first place. Interest rates are at an all-time low and no one seems to care. I don't see any long term solution other than allowing prices to reset naturally. Anything else is just pushing the problem down the line. Unless of course the government is prepared to subsidize housing forever (which they kind of already do at great cost with the mortgage interest deduction). I wonder how things would be if the government never got into housing manipulation business. Perhaps more people would rent. Oh, the HORROR!
