Sunday :: Jun 14, 2009

Paul Krugman on the State of the Recession

by Mary

Will Hutton of The Guardian has an interesting interview with Dr. Krugman about the current state of the global economy and his fear that the world could face stagnation. One thing that comes back to me again and again when reading Krugman's analysis, is how we are truly in unchartered waters and there are still some enormously challenging times ahead.

The crisis can be boiled down to too much debt, the liquidity trap and no foreseeable way out of the hole we are in.

PK: The thing about Japan, as with all of these cases, is how much people claim to know what happened, without having any evidence. What we do know is that recessions normally end everywhere because the monetary authority cuts interest rates a lot, and that gets things moving. And what we know in Japan was that eventually they cut their interest rates to zero and that wasn't enough. And, so far, although we made the cuts faster than they did and cut them all the way to zero, it isn't enough. We've hit that lower bound the same as they did. Now, everything after that is more or less speculation.

...In their case, the problems had a lot to do with demography. That made them a natural capital exporter, from older savers, and also made it harder for them to have enough demand. They also had one hell of a bubble in the 1980s and the wreckage left behind by that bubble - in their case a highly leveraged corporate sector - was and is a drag on the economy.

The size of the shock to our systems is going to be much bigger than what happened to Japan in the 1990s. They never had a freefall in their economy - a period when GDP declined by 3%, 4%. It is by no means clear that the underlying differences in the structure of the situation are significant. What we do know is that the zero bound is real. We know that there are situations in which ordinary monetary policy loses all traction. And we know that we're in one now.

WH: So your point is that the crisis in Japan was about excess debt, excess leverage and lack of demand - reinforced by the fallout from the asset bubble collapsing. They didn't have credit contraction on anything like our scale, but even so, zero interest rates were just unable to turn the economy around.

PK: That's right, that's right.

...I hope I'm wrong but the question you always have to ask is: where do we think that this recovery's going to come from? It's not an easy story to tell.

Having read Dr. Krugman's The Return of Depression Economics and the Crisis of 2008, I found myself wondering how he feels having spent decades researching and studying these financial anomolies only to find himself now being asked to help the world find what will be the magic bullet that will help pull us out of these economic doldrums.

Mary :: 10:26 AM :: Comments (7) :: Digg It!