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Love him or hate him Paul Krugman has been awfully right with regards to the macro picture in the last few years.  He’s one of the rare economists who had the foresight to see the housing bubble and the likelihood of economic downturn that would result from it.  Krugman recently caused a stir when he said the US economy was headed for the third depression.  He isn’t backing down from that outlook:

“I’ve had a couple of conversations lately with people who follow politics and public affairs, but aren’t that close to the economic discussion — and I’ve discovered that there are two comforting delusions still out there.

Delusion #1 is that we’re on the road to recovery, just more slowly than we’d like; to be fair, the White House keeps saying this.

But it’s not at all true. GDP is growing below potential; employment, even if you focus just on private employment, is growing more slowly than the working-age population. If you ask how long it will take us to return to, say, 5 percent unemployment on the current track, the answer is forever.

Delusion #2 is the belief that the stimulus may yet do the trick, because there are still substantial funds unspent. I tried to deal with this last year. The level of GDP depends not on total funds spent, but on the rate at which funds are being spent, which has already peaked; GDP growth on the rate of change in the rate at which funds are being spent, which peaked last year. It’s all downhill from here.”

If you can ignore the schizophrenic market for just a second it’s hard to reject Krugman’s macro outlook.  The private sector has been running on fumes since the debt bubble burst in 2007.  The government’s extraordinary actions helped bolster the economy, but merely papered over what was a very weak private sector.  As we see the government step aside it’s difficult to imagine that the weakness at the private sector won’t again be exposed for what it really is.

Update: This is from Professor Krguman’s weekend op-ed titled “1938 in 2010”:

“The economic moral is clear: when the economy is deeply depressed, the usual rules don’t apply. Austerity is self-defeating: when everyone tries to pay down debt at the same time, the result is depression and deflation, and debt problems grow even worse. And conversely, it is possible — indeed, necessary — for the nation as a whole to spend its way out of debt: a temporary surge of deficit spending, on a sufficient scale, can cure problems brought on by past excesses.

But the story of 1938 also shows how hard it is to apply these insights. Even under F.D.R., there was never the political will to do what was needed to end the Great Depression; its eventual resolution came essentially by accident.

I had hoped that we would do better this time. But it turns out that politicians and economists alike have spent decades unlearning the lessons of the 1930s, and are determined to repeat all the old mistakes. And it’s slightly sickening to realize that the big winners in the midterm elections are likely to be the very people who first got us into this mess, then did everything in their power to block action to get us out.

But always remember: this slump can be cured. All it will take is a little bit of intellectual clarity, and a lot of political will. Here’s hoping we find those virtues in the not too distant future.”

The more things change the more they stay the same….

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