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Vol. LXIII, No. 43
Wednesday, October 28, 2009
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Though No Apocalypse Is Seen on Horizon, Prof. Krugman Predicts a Long Stagnation

Dilshanie Perera

The good news, according to Nobel Prize-winning economist and Princeton Professor Paul Krugman, is that we are not replaying the second year of the Great Depression.

“Apocalypse not now,” he said during a Woodrow Wilson School-sponsored lecture, “The Return of Depression Economics?” last week.

But while we are no longer on the brink of disaster, Mr. Krugman worried that our future might consist of a prolonged stagnation, like the Japanese “Lost Decade,” which followed the collapse of the Asian markets in the late 1990s.

The first year of the current economic crisis was almost a “full match” to the first year of the Great Depression in terms of “world industrial production, world trade, unemployment, and a tremendous amount of human damage,” Mr. Krugman said.

The impetus for the crash was the “biggest mispricing and overvaluation of housing” in the United States and other countries around the world. “I still remain amazed by how few people called those bubbles,” Mr. Krugman remarked, adding that “it was the clearest craziness I’ve ever seen in my life.”

Mr. Krugman admitted he didn’t realize “how far gone” the financial system had also been, so that when the housing bubble burst, the financial system went down with it. Deregulation of the banks had begun in the 1980s, when legislation was passed to allow banks to lend with far less collateral, he said.

More recently, there had been a “proliferation of ‘banking-type arrangements’” like auction rate securities, the reposession market, and the shadow banking system, Mr. Krugman said.

While the collapse brought about “a huge amount of human suffering,” Mr. Krugman suggested that we were “inoculated against a second Great Depression because of the first,” listing actions and characteristics that prevented a deeper crisis.

Among them were the “aggressive policies” of Former Princeton University Professor and current Chairman of the Federal Reserve Ben Bernanke, whose academic papers became a policy template, Mr. Krugman said.

Additionally, having a big government helped. He noted that “Automatic stabilizers” like Social Security checks and Medicare, were still being received.

Mr. Krugman also characterized the U.S. government’s budget deficit as good policy, since “deficits saved the world this time around.” Job creation also alleviated unemployment to a small extent, he added.

“We have stepped back from the abyss, but how do you recover? How do you start getting jobs back?” Mr. Krugman asked. “People have been doing a lot of looking at history to figure out what is going on.”

It becomes harder to recover when many households have balance sheets out of order, and when the crises occur in a number of other countries at once, Mr. Krugman said, adding that in the past, export-led recoveries and trade surpluses paved the way for recovery, but that the global recession makes that strategy unlikely.

“It’s difficult to get people to wrap their minds around how different things are,” Mr. Krugman asserted, saying that we are experiencing an “Alice-through-the-looking-glass world economically,” in which government deficits are good, and prudence is foolish.

“We’re going to be living in a world of depression economics for a long time to come,” Mr. Krugman said.

During the question and answer session that followed his lecture, Mr. Krugman assured those present that inflation is not a concern, and that deficit financial fears are exaggerated. Unsure about the status of the “Big Three” U.S. automakers, he noted that “even if they do go under, we will still have an auto industry here … the fall in the dollar will help make it easier for the industry to survive.” Expensive commodities are probably part of the future as well, he said.

“There will come a time when we need to be conventionally responsible again,” Mr. Krugman said, though these days he finds himself quoting St. Augustine, “Oh Lord, grant me continence and celibacy … just not now.”

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