End this Depression Now!, by Paul Krugman, Norton, RRP £14.99, 272 pages
As the financial crisis eased in late 2009 and early 2010, a holy war was joined between two economic priesthoods. The Austerians, as Paul Krugman calls them, were aghast at the huge budget deficits left behind by the crisis and the laxity of low interest rates. These, they said, were not the path of righteousness and recovery.
The Stimulati – a rival order in which Krugman is revered – argued that with unemployment so high the only sensible thing to do was spend more and cut interest rates to zero and beyond. The Austerians and the Stimulati said many nasty things about each other. But with crisis-fatigue setting in the Stimulati’s preaching was little heeded, and in countries such as the UK, the Austerians found an audience.
A few years on, the Greek public is rebelling against a ferocious budget squeeze, France has elected its first socialist president since 1995, and the US is preparing for an election in the shadow of an 8.1 per cent unemployment rate. Krugman has picked a good time to unleash a thoroughly persuasive polemic against premature fiscal austerity in the wake of a deep recession.
He does so in a remarkably easy style for a Nobel prize-winning economist, making his case with the help of the confidence fairy, the Fed Borg, bond vigilantes and pop culture references from John Ford to Calvin and Hobbes. End This Depression Now! is a short book that shows some signs of hasty assembly from the raw materials on Krugman’s New York Times blog – the same economists get introduced afresh in different chapters, for example – but it’s lively and readable.
Krugman’s basic argument runs like this. Millions of unemployed are suffering at terrible social cost in the US because the economy lacks demand. The government can create demand by spending; the Fed can create demand by cutting interest rates. There is minimal reason to fear that more spending will cause a debt crisis in the US. Therefore, the authorities should get on with it already, and end this depression now.
You can argue otherwise, and some economists do, but most evidence from the last few years suggests that Krugman is basically right. If high unemployment was structural then inflation would have started to go up by now. US Treasury bond yields have gone down even as US debt has risen. A preponderance of studies show that, when interest rates are stuck at zero, government spending has a large effect on the economy.
Krugman spends 11 chapters running through what is wrong with the US economy and the eurozone, criticising an inadequate policy response to date, and beating up various academic enemies. By the time he gets to his solution you are ready for something really drastic – a revival of the 1930s Public Works Administration, perhaps.
But what he actually wants is threefold, fairly modest, and not entirely convincing as a programme to end a depression now. First, Krugman suggests a fiscal stimulus in the form of $300bn a year to support state and local governments in the US, which have been laying off teachers and other staff to balance their budgets. This makes sense. It could be enacted quickly, should not be prone to waste, and could bring forward the creation of several million jobs at a modest net budgetary cost. It would, however, require a dramatic change in a US political debate in which Republicans are running very successfully against “the debt”.
Second, Krugman argues that Fed chairman Ben Bernanke has been assimilated by a central bank hive mind, and should break free and generally stir the place up by gunning for 4 per cent inflation instead of 2 per cent. In theory, this would encourage everyone to spend and invest more now, while eroding the real value of debt.
But there are several practical issues. One is the central bank’s credibility. Raise your inflation target once and no one will believe you when you promise not to do it again. Markets would probably add an extra inflation risk premium to longer term debt – a real and immediate cost.
Another issue is how quickly the Fed could deliver on a pledge of higher inflation. The mere news of a higher target might be enough to lead workers to demand higher wages and so push up prices, but just as likely the Fed would have to try ever more extreme versions of quantitative easing, which would only work well as the economy picked up and high inflation became less desirable.
Third, Krugman calls for more action on housing, to help households with high interest rates refinance at today’s lower rates. The Obama administration has made some progress in this area but again, absent the injection of more public money or aggressive legislation that would be hard to pass, it is hard to see a change that could make a dramatic economic difference.
Krugman’s book may persuade governments to limit further austerity and that would be a fine thing. The caution of his own proposals, however, suggests that he knows how hard it will be to lure them back into the depression-ending business.
Robin Harding is the FT’s US economics editor