Review: Return of Depression Economics

While looking through my computer for something to fill my time, I came across an audio book of The Return of Depression Economics and the Crisis of 2008. Paul Krugman wrote the first edition of his book following the Asian Financial Crisis of 1997-1998; he updated it in 2008 to include the events of the following ten years. This update not only gives his original history of the crises of the 1990s (including the Savings and Loan Scandal, Japan’s “Lost Decade,” and the Latin American currency crises), it chronicles the dot.com bust, the Fed’s interest rate decisions, the shift to real estate mania, and the troubles in the U.S. financial system. However, it’s not just a history lesson of what everyone did to mess themselves up – Krugman explains how each nation dealt with their crises and the new problems those responses created. For example, Argentina introduced a currency board to tame its hyperinflation problem, only to find in 2002 that this left its system vulnerable to a bank run. There are three lessons from all this. First is that economic recessions are caused by fear, whether justified by economic imbalances or self-induced panic. The key is flicking the right switch. The true cause of the Great Depression was not the stock market crash – it was bank failures. Had the banking system not collapsed, it’s possible markets could have recovered within just a few years. First is that recessions are normal economic events that happen to economies without regard to particular characteristics. They don’t happen as a result of cronyism or too many state-owned enterprises (though those weaknesses can contribute to the severity of the eventual decline). The key is finding the right switch. Second, we are at the end of the rope in terms of Keynesian solutions. Since Black Friday of 1987, the Federal Reserve’s textbook response to a crisis has been to lower interest rates. Unfortunately, the U.S. has become stuck in a liquidity trap of the sort that affected Japan in the 1990s – near zero interest rates but a persistently sluggish economy. Not even stimulus packages are working. We need new thinking to solve this kind of problem. Lastly, we need to spend more time and energy studying the economics of recessions. It’s a field of study that has been widely ignored in favor of other, more “upbeat” subjects, yet is crucial to finding a wise course of action. Krugman provides a lot of insight into the inner workings of economics on the largest scale; this is a great book to read (or listen to) for an understanding of our current mess. The downside is that – having been written in 2008 – it doesn’t provide an explanation as to why our recovery continues to be weak, and it can’t evaluate the success of the Troubled Asset Relief Program (TARP). Nevertheless, if you’re looking for a good introduction to understanding financial crises, this is a great one, and I’d definitely recommend this before either of the other economic books I’ve recently reviewed -- Andrew Sorkin's Too Big to Fail and Gregory Zuckerman's Greatest Trade Ever.