The Return of Depression Economics [Paperback]

Paul Krugman (Author)

Book Description

Series: Open Market Edition | Publication Date: May 15, 2000

Surely the Great Depression could never happen again.

Today, the tragedy of the Great Depression looks gratuitous and unnecessary: Our economists and policy makers simply have gained too much experience since then. It could never happen again. Or could it? Over the course of the last two years, six Asian economies have experienced an economic slump that bears an eerie resemblance to the Great Depression. Russia defaulted on its debt in 1998—an event that, halfway around the world, drove Brazilian interest rates through the roof and terrified the U.S. bond market. Some of the brightest financiers in the world, working for the Long-Term Capital Corporation, thought they had the market licked only to find themselves in a jam that had all the makings of the overleveraged positions that caused the 1929 stock market crash. Paul Krugman, one of the world's top economists, recounts these events and more: He points out that they raise significant questions for which policy makers may not have answers. This paperback edition features a brand-new preface by Krugman on the financial realities of the past year.

Editorial Reviews

Amazon.com Review

What do babysitting coops and liquidity traps have in common? Lots, according to Paul Krugman. In The Return of Depression Economics, the MIT professor looks at the alarming string of financial crises that plagued various economies around the globe in the 1990s, especially the Asian contagion, and sees an "eerie resemblance to the Great Depression." Instead of the "new world order" promised by the triumph of capitalism over socialism, "the world economy has turned out to be a much more dangerous place than we imagined."

Krugman uses the example of a Washington, D.C., babysitting coop to explain the dynamics of recession and inflation. He examines the remarkable emergence of Asia and the precursors to the Asian mess--the Tequila Effect of the mid-'90s that began in Mexico and Japan's fall in the early '90s into an economic malaise. He then analyzes the underlying reasons for the collapse of the Thai baht and other Asian currencies as well as the subsequent actions of the IMF and the murky role of hedge funds. In the end, Krugman sees the return of depression economics, which "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." It's the same problem that was at the root of the 1930s depression. And while it took a world war to solve that problem, Krugman sees solutions that are far less dramatic but that do require a willingness to chuck obsolete doctrines and think about old problems in new ways.

Over the years, Krugman has earned a well-deserved reputation for translating the jargon that economists speak into something that anyone with an interest--not necessarily a Ph.D.--can understand. The Return of Depression Economics is another timely testament to Krugman's ability to read and interpret the tea leaves of today's global economy. Highly recommended. --Harry C. Edwards --This text refers to an out of print or unavailable edition of this title.

From Publishers Weekly

As an economist in good standing, writes MIT economist Krugman, I am quite capable of writing things that nobody can read. Fortunately, Krugman, author of Slates Dismal Science column, is also quite capable of writing things that almost anyone can read. An accomplished translator of economics into English, Krugman (Peddling Prosperity; The Accidental Theorist; etc.) takes a look at the international financial turmoil of the past two years and concludes that, confident assertions of happy globalizers and bullish day traders notwithstanding, a great depression could happen again. Depression economics is back, he argues, meaning that for the first time in two generations, failures on the demand side of the economy... have become the clear and present limitation on prosperity for a large part of the world. Whether discussing the currency collapse in Indonesia, the travails of Brazil and Russia (and how theyre related) or the failure of hedge funds such as Long Term Capital Management, Krugman writes with invigorating lucidity and forceful opinion. Now as in the 1930s, however, one cannot defend globalization merely by repeating free-market mantras, even as economy after economy crashes. If his message is dire, his tone is light, almost jaunty as he calls supply-side economics a crank doctrine and ably articulates a Keynsian willingness to regulate markets in order to stabilize economies and minimize human suffering. Moving from concrete examples (e.g., the struggles of a Japanese baby-sitting coop) to stinging critiques of head-in-the-sand theorists, Krugman proves himself not only comprehensible but also well worth comprehending.
Copyright 1999 Reed Business Information, Inc. --This text refers to an out of print or unavailable edition of this title.

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Product Details

• Paperback: 176 pages
• Publisher: W. W. Norton & Company (May 15, 2000)
• Language: English
• ISBN-10: 0393320367
• ISBN-13: 978-0393320367
• Product Dimensions: 8.1 x 5.4 x 0.6 inches
• Shipping Weight: 8 ounces
• Average Customer Review: 4.1 out of 5 stars  See all reviews (62 customer reviews)
• Amazon Best Sellers Rank: #976,994 in Books (See Top 100 in Books)

More About the Author

Paul Krugman is the recipient of the 2008 Nobel Prize in Economics. He writes a twice-weekly op-ed column for the New York Times and a blog named for his 2007 book "The Conscience of a Liberal." He teaches economics at Princeton University. His books include "The Accidental Theorist," "The Conscience of a Liberal," "Fuzzy Math," "The Great Unraveling," "Peddling Prosperity," and two editions of "The Return of Depression Economics," both national bestsellers.

Customer Reviews

Most Helpful Customer Reviews

50 of 57 people found the following review helpful:

4.0 out of 5 stars Interesting and useful..., January 18, 2000

By 

Professor Joseph L. McCauley "Joseph L. McCauley" (Austria+Texas) - See all my reviews

Amazon Verified Purchase

This review is from: The Return of Depression Economics (Hardcover)

This book is interesting, worth reading, in part because of it's attempt to avoid moralizing and to find instead `mechanical' reasons for economic slumps, and also for its presentation of facts about sequences of events. The book is also short: the presentation and arguments are concise and easy to follow. The mechanics emphasized by Krugman are large (often leveraged) money transfers and leveraged credit. The examples discussed are about Japan, Thailand, Mexico, Russia, and Brazil. Money transfers via hedge funds are nicely discussed.

Japan, seen from a western economist's eyes, presents a problem economy: stable currency and employment (no growth), and high savings (people tend to keep their money in the bank). Krugman labels this no-growth/high liquidity state a `liquidity trap'. He describes a toy economy that provides a model of a liquidity trap, the Washington DC Baby-sitters' Co-op (see also Akerlof's `Market for Lemons', which came earlier). In the baby-sitter's co-op people start with small, equal amounts of script and a state is reached where parents want baby-sitters (demand) and other parents want to baby-sit (supply) but there is no matching of demand to supply because the script supply (money supply) is too small (savings are too high). Krugman's proposed solution to the liquidity trap is to inflate the script supply. That is also his proposed solution for destabilizing Japan's economy and society: to make saving less desirable by inflating the money supply, therefore inducing people to consume and speculate. The interesting thing is that on Thursday, 14 October 1999, that is exactly what the Bank of Japan agreed to do by announcing that they are buying back bonds. So, we now have running an uncontrolled experiment of Krugman's proposal.

Krugman presents elsewhere a mathematical model of the liquidity trap (see his web page), but it's based on the mythology of a utility function and is only a static model with no dynamics and no time scales. Unfortunately, there is really no correct existing theory of liquidity traps, because `utility maximization' is not an equilibrium condition and does not predict anything measurable real data. As for Japan, one might ask: why label their society as a "problem" just because the economy and currency are stable, especially since people save a lot and there is as yet no large-scale unemployment? The reasons that they tend to save rather than speculate by buying stocks and bonds are several-fold: (1) the mafioso nature of Japan's finance system, where people got burned very badly in the last bubble (see Devil Take the Hindmost, by Edward Chancellor), (2) high financial friction, or large brokerage fees (soon to be destroyed by the introduction of discount brokerage houses into Japan as of 1 October 1999), and (3) the fact that Japan has no social security system. If we ask why western politicians and economists persistently label Japanese habits as `problematic', the answer could well be an unquestioning, bordering-on-dogmatic belief in the econo-religion of growth and progress by the accusers. French farmers rebelled with very good reason against European Union demands for `optimization'.

Peter Drucker pointed out in 1983 in The Frontiers of Management that trade in goods and services no longer determines exchange rates, that money transfers/month across international borders are many times the value of exports/imports. This fact, that the size of money transfers dominates everything, plays a key role in Krugman's analysis. He replays for the reader the tape from (Thailand, 1997 and) Brazil (fall, 1998) where, with still non-increasing prices, but at the onset of an economic slump, Brazil's currency came under pressure due to fallout from the collapse of Russia. Brazil tried to devalue slightly and the currency was routed (via hedge funds). Krugman poses the general question why, when a currency (like the Baht or Real) is weak, and the government (either credit-leveraged Thailand or unleveraged-Brazil) tries to devalue slightly, the devaluation tends to turn into a run on the currency. The answer, he asserts, is that this happens because people believe that it will happen, and this belief then makes it happen (via hedge funds). In other words, a self-fulfilling expectation is created. This rings true because it reminds me of Feynman's observation (in Surely You're Joking, Mr. Feynman) that socio-economic phenomena are not like physics or mathematical laws of nature. In the latter belief doesn't count (you can't make it rain by wishing, and a billiard ball can't think and change its path), whereas in the social arena you can act on beliefs and then cause things to happen.

Summarizing, in comparison with Krugman's book The Self-Organizing Economy, where he seems only to parrot ideas that he didn't invent and doesn't understand (I got this impression in the early pages and so did not read further), I found The Return of Depression Economics to be both enjoyable and informative.

17 of 17 people found the following review helpful:

5.0 out of 5 stars Krugman makes serious analysis fun to read., July 8, 1999

By A Customer

This review is from: The Return of Depression Economics (Hardcover)

From the July/August 1999 issue of FOREIGN AFFAIRS: A sober -- and sobering -- appraisal of the past two years of financial history. The book covers the unstable dynamics of financial crises, highly leveraged hedge funds, Japan's deflation and liquidity trap, and other economic pathologies. Krugman argues that deficient demand, which has not appeared on such a global scale since the 1930s, is again a potential problem. When appropriate, countries should pursue an expansionary monetary and fiscal policy -- to revive the "Keynesian compact," whereby they maintain free markets but provide government-assured adequate aggregate demand. Krugman also usefully reminds us that economics is a set of analytical tools applicable to diverse situations, not a rigid set of universal principles. He concludes that the Japanese government should generate inflationary expectations so that the real interest rate can decline further -- an unorthodox conclusion carefully derived from straightforward economic analysis. He tells his story in clear prose, without the diagrams economists love. Masterful at presenting complex ideas in simple and sometimes whimsical parables and analogies, Krugman makes serious analysis fun to read.

14 of 15 people found the following review helpful:

5.0 out of 5 stars Why old problems bite back, February 8, 2001

By 

Kirill Pankratov - See all my reviews

This review is from: The Return of Depression Economics (Paperback)

The beginning of the previous decade saw the establishment of a new doctrine - and almost unbounded optimism about its power: triumph of markets over states, new role of IMF as a policemen of the world economy, "Washington Consensus" about the strict rules that "emerging market" countries are supposed to follow. Later, in the second half of the decade a new impetus was added - rapid development of the Internet and new telecommunication technologies. The olden stuff of economic theories - business cycle, limits of non-inflationary growth - seemed quaint and irrelevant. Isn't today's economy all about "faster, not bigger", bits, not atoms, megabytes per second, not megatons? Not so fast, argued Paul Krugman in this book. It turns out that problems and issues relegated to the history museum have a knack of coming back with a vengeance.

"The Return of The Depression Economics" doesn't mean that the whole world is about to experience the equivalent of the global "Great Depression" of 1930's. Rather, that many countries are now facing problems similar to big issues that occupied economists and policy-makers in the wake of the great shock of world economy in 1930's. At the core of these problems is a massive and long-term demand failure that some economies experience in the aftermath of previous booms. Unlike a recession - a temporary downturn which can be cured by lowering interest rates (injecting money into financial markets), a depression is a state of the economy so out of balance and with destroyed credibility of the financial system, that extra central banks money or fiscal programs is not transferred into productive investments, but stashed away into savings (or leave the country), which further decreases consumption and reinforces downward cycle.

"Depression economics" - a classical Keynesian approach originated from the Great Depressions - deals with problems that are usually tackled by "demand-side" recipes. Its own failures since then led to the emergence of the "supply-side" economics in the late '70-early `80s. It concentrated on unclogging the production side of the market equilibrium - such as cutting taxes, deregulation and privatization. Solid economic foundations of such policies were somewhat lacking (Krugman even dismissively calls them "crank theories"), but it did help solving some problems that plagued western economies in previous decades.

This set of recipes, however, created its own problems. In case of "emerging markets" these prescriptions are incorporated in IMF and "Washington Consensus" orthodoxy. Although seemingly unrelated, they had much in common with "supply-side" ideology. They include restrictive anti-inflationary monetary policy, privatization, deregulation, opening to foreign markets and generally reducing role of the state. At first they seemed to be successful. In particular they led to dramatic reduction of inflation, endemic in the many developing countries. But that, as it increasingly turns out, was an easy part. The crises of the last several years, which P. Krugman describes in details, occurred precisely in those countries that accepted IMF polices. Like with any orthodoxy, the assertion that the causes of these crises are that these countries didn't adhere to them strictly enough doesn't have much merit - the real world never fully conforms to theories.

Many states in fact repeated the boom-bust cycle along the similar lines. At first a monetary "shock therapy" succeeds in stamping inflation - for good, it seems. Domestic and foreign capital flows into privatization projects, government and corporate bonds, attracted by high interest rates prescribed by IMF policies. But country's immature financial system is unable to fully digest the influx of money. This leads to rapid overheating of comprador parts of the economy - nascent stock markets and real estate prices in the nation's capital. Inflation is re-ignited, though to a lesser degree. As the exchange rate is kept steady, soon the country's currency becomes overvalued, and a big trade deficit develops because of uncompetitiveness of the country exports. At the same time local demand stagnates (except the parts directly connected to foreign capital inflow), much of the country plunges into severe depression. At first this usually doesn't concern visiting IMF officials and foreign consultants, seeing new 5-star hotels and Mercedes dealerships. But then markets begin to smell trouble. Triggered by some crisis, interest rates suddenly shoot up and capital stampedes out, forcing the government to spend even more of its budget to pay debts and defend its currency. IMF may come up with a bailout package, but it represents only a temporary solution, solving none of the fundamental problems. Sometimes the crisis abates, leaving a country with bigger debt and more precarious long-term conditions; sometimes it can culminate in a huge storm, like 1997-98 crises that swept many "emerging markets".

These storms that Krugman describes in his book are the crises of globalization, brought about by extreme liquidity and instability of the world financial system. Consider an irrigation system consisting of many reservoirs of various sizes and shapes, connected by a network of pipes and channels. One day a big name engineering consultant appears and prescribes full opening of all sluices and floodgates for more efficient water circulation. At first glance this has only advantages. But when things turn bad (as they inevitably do once in a while) it can affect smaller parts much worse than if they were more shielded from the rest of the system. Big tides and storms mean only fluctuations for larger pools, but can completely drain little reservoirs and devastate weaker areas.

It is no surprise that today one of the most precarious financial conditions exist in Argentine - a country that was the poster child of the IMF programs and "Washington Consensus" philosophy. This philosophy seems stuck in ideas of 10 or more years ago, with very little accommodation of new experience. It is failing now and succumbing to problems already encountered long ago - but where new solutions are called for.