[At the end I provide links to charts from his blog that illustrate some of his points]
http://www.nytimes.com/2009/06/15/opinion/15krugman.html
The New York Times
June 15, 2009
Op-Ed Columnist
Stay the Course
By PAUL KRUGMAN
The debate over economic policy has taken a predictable yet ominous
turn: the crisis seems to be easing, and a chorus of critics is already
demanding that the Federal Reserve and the Obama administration abandon
their rescue efforts. For those who know their history, it's déjà vu
all over again -- literally.
For this is the third time in history that a major economy has found
itself in a liquidity trap, a situation in which interest-rate cuts,
the conventional way to perk up the economy, have reached their limit.
When this happens, unconventional measures are the only way to fight
recession.
Yet such unconventional measures make the conventionally minded
uncomfortable, and they keep pushing for a return to normalcy. In
previous liquidity-trap episodes, policy makers gave in to these
pressures far too soon, plunging the economy back into crisis. And if
the critics have their way, we'll do the same thing this time.
The first example of policy in a liquidity trap comes from the 1930s.
The U.S. economy grew rapidly from 1933 to 1937, helped along by New
Deal policies. America, however, remained well short of full
employment.
Yet policy makers stopped worrying about depression and started
worrying about inflation. The Federal Reserve tightened monetary
policy, while F.D.R. tried to balance the federal budget. Sure enough,
the economy slumped again, and full recovery had to wait for World War
II.
The second example is Japan in the 1990s. After slumping early in the
decade, Japan experienced a partial recovery, with the economy growing
almost 3 percent in 1996. Policy makers responded by shifting their
focus to the budget deficit, raising taxes and cutting spending. Japan
proceeded to slide back into recession.
And here we go again.
On one side, the inflation worriers are harassing the Fed. The latest
example: Arthur Laffer, he of the curve, warns that the Fed's policies
will cause devastating inflation. He recommends, among other things,
possibly raising banks' reserve requirements, which happens to be
exactly what the Fed did in 1936 and 1937 -- a move that none other
than Milton Friedman condemned as helping to strangle economic
recovery.
Meanwhile, there are demands from several directions that President
Obama's fiscal stimulus plan be canceled.
Some, especially in Europe, argue that stimulus isn't needed, because
the economy is already turning around.
Others claim that government borrowing is driving up interest rates,
and that this will derail recovery.
And Republicans, providing a bit of comic relief, are saying that the
stimulus has failed, because the enabling legislation was passed four
months ago -- wow, four whole months! -- yet unemployment is still
rising. This suggests an interesting comparison with the economic
record of Ronald Reagan, whose 1981 tax cut was followed by no less
than 16 months of rising unemployment.
O.K., time for some reality checks.
First of all, while stock markets have been celebrating the economy's
"green shoots," the fact is that unemployment is very high and still
rising. That is, we're not even experiencing the kind of growth that
led to the big mistakes of 1937 and 1997. It's way too soon to declare
victory.
What about the claim that the Fed is risking inflation? It isn't. Mr.
Laffer seems panicked by a rapid rise in the monetary base, the sum of
currency in circulation and the reserves of banks. But a rising
monetary base isn't inflationary when you're in a liquidity trap.
America's monetary base doubled between 1929 and 1939; prices fell 19
percent. Japan's monetary base rose 85 percent between 1997 and 2003;
deflation continued apace.
Well then, what about all that government borrowing? All it's doing is
offsetting a plunge in private borrowing -- total borrowing is down,
not up. Indeed, if the government weren't running a big deficit right
now, the economy would probably be well on its way to a full-fledged
depression.
Oh, and investors' growing confidence that we'll manage to avoid a
full-fledged depression -- not the pressure of government borrowing --
explains the recent rise in long-term interest rates. These rates, by
the way, are still low by historical standards. They're just not as low
as they were at the peak of the panic, earlier this year.
To sum up: A few months ago the U.S. economy was in danger of falling
into depression. Aggressive monetary policy and deficit spending have,
for the time being, averted that danger. And suddenly critics are
demanding that we call the whole thing off, and revert to business as
usual.
Those demands should be ignored. It's much too soon to give up on
policies that have, at most, pulled us a few inches back from the edge
of the abyss.
<end article>
Charts:
How hugely increasing monetary base didn't cause inflation in previous liquidity traps:
http://krugman.blogs.nytimes.com/2009/06/13/way-off-base/
How private borrowing is still negative:
http://krugman.blogs.nytimes.com/2009/06/11/private-borrowing-is-still-negative/
Comic relief: what unemployment did in the months after Reagan's tax cut:
http://krugman.blogs.nytimes.com/2009/06/14/stimulus-history-lesson/