Bubble, bubble, toil and trouble



Whoever designed my 1996 GCSE history syllabus was, in hindsight, inspired. One of the modules was on the Roaring Twenties in the US. We learned about jazz, flappers, prohibition and so on, but also about the causes of the Wall Street Crash of 1929. As far as I can remember, it was a mixture of laissez-faire government and excessive hire-purchase of lawnmowers that did for them. But the main thought I came away with was this: how could they be so stupid? Why didn't they see it coming?

The inspired part came a bit later, in 2008. After years of economic hubris, we found out that we're not so very much more sophisticated than our predecessors after all. That's probably the most important lesson history can teach us (after "don't invade Russia"). So how could we be so stupid? Why didn't we see our crisis coming?

The truth, now as then, is that some people did. They just weren't listened to. This time round Paul Krugman was one of those people. Back in 1999 he wrote the first edition of The Return of Depression Economics. It talked about the financial crises of the time - those in Latin America, the fall of the "Asian tigers" (remember them?) and Japan's lost decade - and warned that we ignored them at our peril.

At this time the problem of regulating a developed economy seemed to have been solved. At its most basic level, raising interest rates would prevent it overheating, while lowering them would ward off recession. But in Japan's case in particular, these monetary controls stopped working. Their economic bubble burst, the economy slumped, interest rates fell to zero, but a recovery still didn't arrive. This is the realm of depression economics.

With the aid of a real-life model economy from a babysitting co-op, Krugman explains how this situation can come about. He then points out that all this would be familiar to Keynes and advocates a Keynesian approach to fixing it: deficit spending by governments and, failing that, controlled inflation by quantitative easing (i.e. printing money). If you believe that either of these things is a bad idea, you need to read this book. Preferably before voting.

The other strand of Krugman's argument is a failure of regulation to cope with the modern world of finance. In this our woes resemble the Panic of 1907 as much as the 1930s. What has happened is a shadow banking system has grown, based around exotic arrangements like "auction-rate securities", which allowed organisations like Lehman Brothers to perform bank-like functions without any of the pesky regulations that apply to ordinary banking. Without the costs of regulation, the shadow banking system gave higher returns and grew explosively. But when the economy went pear-shaped, the safety net provided by the regulations wasn't there to save the shadow banks. Instead the long suffering taxpayer has had to foot the bill.

Depression Economics is a well-argued and very clear analysis of our times. My only quibble with this revised edition is that it loses some of its power from looking backwards rather than forwards. It's now less of a warning that came true and more of an "I told you so". It also reads a little awkwardly, with the new events bolted on to the end and the earlier chapters buffed up slightly so they fit in. It's worth it, though, as the analysis of the current crisis in the context of the others adds a lot to the book (not least as it would be a very slim volume without it). It's shocking how our own two bubbles - in dot.coms and housing - and their collapse bear such an uncanny resemblance to the crises of the 90s.

If there's grounds for hope in this book, it's that those in power - and in particular the UK government (go us!) - were alert to the need for action this time round. It seems, touchwood, that we've done enough to prevent another Great Depression, not that the very severe recession we've got instead is much consolation. But if nothing else it's shown that perhaps we are able to learn from history after all.


The Return of Depression Economics and the Crisis of 2008
by Paul Krugman
First published as The Return of Depression Economics, 1999
Revised edition published 2008
Krugman's columns and blog are available on the New York Times website.

Comments

  1. I think as long as we manage not to sandwhich a depression between to two very costly wars we should be alright.....

    Sounds like an interesting book though and I did the 20's and the depression at school too, somebody must have known something.

    ReplyDelete
  2. Actually World War II was exactly the sort of government-backed fiscal stimulus that America needed to pull out of the depression for good.

    Hopefully there are less extreme remedies this time round...

    ReplyDelete

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