What does it mean to say that depression economics has returned? Essentially it means that for the first time in two generations, failures on the demand side of the economy—insufficient private spending to make use of the available productive capacity—have become the clear and present limitation on prosperity for a large part of the world.
What the world needs right now is a rescue operation. The global credit system is in a state of paralysis and a global slump is building momentum. Reform of the weaknesses that made the crisis possible is essential, but it can wait a little while. First, we need to deal with the clear and present danger. To do this, policy makers around the world need to do two things: get credit flowing and prop up spending.
The first task is the harder of the two, but it must be done and soon. The obvious solution is to put in more capital. In fact that’s a standard response in financial crisis. In 1933 the Roosevelt administration used the Reconstruction Finance Corporation to recapitalize banks by buying preferred stocks. When Japan moved to rescue its banks in 1998, it purchased more than $500 billion in preferred stock, the equivalent of around a $2 trillion capital injection in the United States. In each case, the provision of capital helped restore the ability of bankers to lend and unfroze credit markets.
My guess is that the recapitalization of the American banking system will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control—in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. Just to be clear: this isn’t a long-term goal, a matter of seizing the economy’s commanding heights: finance should be reprivatized as soon as it’s safe to do so. But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what’s necessary out of fear that acting to save the financial system is somehow “socialist.”
The same goes for another line of approach to resolving the credit crunch: getting the feds, temporarily, into the business of lending directly to the nonfinancial sector. The Federal Reserve’s willingness to buy commercial paper is a major step in this direction, but more will probably be necessary.
All these actions should be coordinated with other advanced countries. The reason is the globalization of finance. Part of the payoff to U.S. rescues of the financial system is that they help loosen up access to credit in Europe; part of the payoff to European rescue efforts is that they loosen up credit here. So everyone should be doing more or less the same thing: we’re all in this together.
The point in all of this is to approach the current crisis in the spirit that we’ll do whatever it takes to turn things around; if what has been done so far isn’t enough, do more and do something different, until credit starts to flow and the real economy starts to recover.
And once the recovery effort is well underway, it will be time to turn to prophylactic measures: reforming the system so that the crisis doesn’t happen again.
Excerpted from The Return of Depression Economics and the Crisis of 2008 by Paul Krugman. Copyright © 2009, 1999 by Paul Krugman. With permission of the publisher, W.W. Norton & Company Inc.
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