Policymakers need to learn from the past:
The Great Abdication, by Paul Krugman, Commentary, NY Times: Among economists who know their history, the mere mention of certain years evokes shivers. For example, three years ago Christina Romer ... warned politicians not to re-enact 1937 — the year F.D.R. shifted, far too soon, from fiscal stimulus to austerity, plunging the recovering economy back into recession. Unfortunately, this advice was ignored.
But now I’m hearing more and more about an even more fateful year. Suddenly normally calm economists are talking about 1931, the year everything fell apart.
It started with a banking crisis in a small European country (Austria). Austria tried to step in with a bank rescue — but the ... rescue put the government’s own solvency in doubt. Austria’s troubles shouldn’t have been big enough to have large effects on the world economy, but in practice they created a panic that spread around the world. Sound familiar?
The really crucial lesson of 1931, however, was about the dangers of policy abdication. Stronger European governments could have helped... Central banks ... could have done much more to limit the damage. But [those] with the power to contain the crisis ... declared that it was someone else’s responsibility.
And it’s happening again... Yet let’s not ridicule the Europeans, since many of our own policy makers are acting just as irresponsibly. And I’m not just talking about Congressional Republicans, who often seem as if they are deliberately trying to sabotage the economy.
Let’s talk instead about the Federal Reserve. The Fed ... expects to fail on both parts of its mandate, with inflation below target and unemployment far above target for years to come. ...
So what does the Fed propose doing about the situation? Almost nothing. ... Why won’t the Fed act? My guess is that it’s intimidated by those Congressional Republicans, that it’s afraid to do anything that might be seen as providing political aid to President Obama, that is, anything that might help the economy. ...[T]he Fed, like the European Central Bank, like the U.S. Congress, like the government of Germany, has decided that avoiding economic disaster is somebody else’s responsibility.
None of this should be happening. As in 1931, Western nations have the resources they need to avoid catastrophe, and indeed to restore prosperity... But knowledge and resources do no good if those who possess them refuse to use them.
And that’s what seems to be happening. The fundamentals of the world economy aren’t, in themselves, all that scary; it’s the almost universal abdication of responsibility that fills me, and many other economists, with a growing sense of dread.