Krugman: Fed Can't Save Us From Great Depression II

The NYT’s Paul Krugman draws three lessons from the current debacle:

  • 70 years of conventional wisdom since the Great Depression has been wrong: The Fed can’t head off depressions with easy money. Thus, GD1 may have been un-preventable.  GD2 may be unpreventable.
  • The only way to avoid GD2 (now) is frantic government spending (fiscal stimulus).
  • The government is about to blow it.  Republican posturing suggests Obama will be forced to cut back and/or delay his spending plans in the name of “prudence” and “conservatism.”

We’d add another possible lesson: There is NO WAY to prevent depressions other than regulating the economy enough to limit booms like the one we’ve had over the past couple of decades.  This is A LOT easier said than done, because, for obvious reasons, everyone loves booms.

Krugman: “If we don’t act swiftly and boldly,” declared President-elect Barack Obama in his latest weekly address, “we could see a much deeper economic downturn that could lead to double-digit unemployment.” If you ask me, he was understating the case.

The fact is that recent economic numbers have been terrifying, not just in the United States but around the world. Manufacturing, in particular, is plunging everywhere. Banks aren’t lending; businesses and consumers aren’t spending. Let’s not mince words: This looks an awful lot like the beginning of a second Great Depression.

So will we “act swiftly and boldly” enough to stop that from happening? We’ll soon find out.

We weren’t supposed to find ourselves in this situation. For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas of the University of Chicago, in his presidential address to the American Economic Association, declared that the “central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression in its tracks simply by providing banks with more liquidity, which would have prevented a sharp fall in the money supply. Ben Bernanke, the Federal Reserve chairman, famously apologized to Friedman on his institution’s behalf: “You’re right. We did it. We’re very sorry. But thanks to you, we won’t do it again.”

It turns out, however, that preventing depressions isn’t that easy after all…

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