Paul Krugman: Fighting Off Depression

Will Congress do what's needed to stop the economy's downward spiral? (Related: Obama Plan Includes $300 Billion in Tax Cuts "to win over Congressional skeptics worried that he was too focused on government spending." Guess who the skeptics are? "Republicans have begun voicing criticism of what they describe as an open-checkbook approach to spending. By focusing more attention on the tax cuts in the plan, Obama aides hope to frame it as a balanced, pragmatic approach." The centrist urge to compromise may give too much away.):

Fighting Off Depression, by Paul Krugman, Commentary, NY Times: “If we don’t act swiftly and boldly,” declared President-elect Barack Obama in his latest weekly address, “we could see a much deeper economic downturn that could lead to double-digit unemployment.” If you ask me, he was understating the case.

The fact is that recent economic numbers have been terrifying, not just in the United States but around the world. Manufacturing, in particular, is plunging everywhere. Banks aren’t lending; businesses and consumers aren’t spending. Let’s not mince words: This looks an awful lot like the beginning of a second Great Depression. ...

We weren’t supposed to find ourselves in this situation. For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas ...  declared that the “central problem of depression-prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression in its tracks simply by providing banks with more liquidity...

It turns out, however, that preventing depressions isn’t that easy after all..., the Fed has been supplying liquidity like an engine crew trying to put out a five-alarm fire... Yet credit remains scarce, and the economy is still in free fall.

Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute ... Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy — large-scale deficit spending... — is needed... The failure of monetary policy in the current crisis shows that Keynes had it right... And Keynesian thinking lies behind Mr. Obama’s plans to rescue the economy.

But these plans may turn out to be a hard sell..., the political posturing has already started, with Republican leaders setting up roadblocks... More broadly, after decades of declaring that government is the problem, not the solution, not to mention reviling both Keynesian economics and the New Deal, most Republicans aren’t going to accept ... a big-spending, F.D.R.-type solution...

The biggest problem..., however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts.

This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment “which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.” What gets lost in such discussions is the key argument for economic stimulus — namely, that under current conditions, a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful.

All of this leaves me concerned... I’m sure that Congress will pass a stimulus plan, but I worry that the plan may be delayed and/or downsized. And Mr. Obama is right: We really do need swift, bold action.

Here’s my nightmare scenario: It takes Congress months to pass a stimulus plan, and the legislation that actually emerges is too cautious. As a result, the economy plunges for most of 2009, and when the plan finally starts to kick in, it’s only enough to slow the descent, not stop it. Meanwhile, deflation is setting in, while businesses and consumers start to base their spending plans on the expectation of a permanently depressed economy — well, you can see where this is going.

So this is our moment of truth. Will we in fact do what’s necessary to prevent Great Depression II?

Update: On the point that fiscal policy requires "proof that the benefits of the proposed public spending justify its costs — a burden of proof never imposed on proposals for tax cuts," Ed Glaeser:

...macroeconomic events should never lead us to toss out the first rule of prudent policy: fund projects only when benefits exceed costs... What will minimize the risks of a fiscal fiasco? [One possibility is] new tax cuts for middle-income Americans... Tax cuts can be implemented quickly and entail minimal waste... Even if the tax cut doesn't end the recession, it  would at least ease the downturn's burden on poorer Americans. ... The country should take infrastructure investment seriously, but infrastructure spending is unlikely to be sound stimulus. ...