Wednesday, 10 June 2009

Paul Krugman in London part 1 - the recession

Unlike some people, I managed to get tickets for Paul Krugman's series of lectures at the London School of Economics this week.

It's been very interesting, and has already reached the news. Yesterday he announced that he expected the recession to officially end this summer, and the Dow Jones index immediately jumped about 70 points. Ironically, Krugman said in the same lecture that the stockmarket is not a signal of recovery - though he didn't quite say that the stockmarket wouldn't respond to signals of a recovery. I think the phrase was "what the hell does the stockmarket know".

Oddly, the Bloomberg report of yesterday's comments (which portrayed them positively) has been replaced with a much more pessimistic report of what Krugman said tonight. Yesterday, this link read:
June 8 (Bloomberg) — The U.S. economy probably will emerge from the recession by September, Nobel Prize-winning economist Paul Krugman said.

“I would not be surprised if the official end of the U.S. recession ends up being, in retrospect, dated sometime this summer,” he said in a lecture today at the London School of Economics. “Things seem to be getting worse more slowly. There’s some reason to think that we’re stabilizing.”
Today, the very same page reads:
June 9 (Bloomberg) -- Nobel Prize-winning economist Paul Krugman said damage from the U.S. recession may persist “for a very long time,” with no clear engine for renewed growth.

“I’m really quite scared that we could muddle along,” Krugman said in a lecture today at the London School of Economics and Political Science. “I really do see the possibility of a global version of the Japanese ‘lost decade’ without the prospect of an export-led recovery. This could be unpleasant for a very long time.”
Funny, eh!

But the tone wasn't negative in general, even though he admits to a lot of uncertainty about how and when a real recovery will come. The Prospect link above has a good summary of what he said on the first night, so I won't repeat it. But some other notes:

He's quite fun. His updated book, The Return of Depression Economics, stresses that the writing (and some of the economic models, like the babysitting circle) will be playful. His style in person is the same, and it makes him very likeable. While that isn't supposed to be a factor in evaluating someone's arguments, it undoubtedly makes us more sympathetic to what he says.

Perhaps that's part of why I found him more persuasive than I'd expected. I've always been sympathetic to the Keynesian view of which Krugman is chief exemplar, but after reading lots of Scott Sumner, Nick Rowe and others in recent months, I've started to be more cautious about it. But Krugman made a pretty good case for deficit stimulus, convincingly arguing against any notion of crowding-out and demonstrating that government borrowing and spending will actually increase private investment and consumption by preventing the economy getting stuck in a paradox of thrift.

This does depend on the notion that monetary policy is ineffective at the zero interest rate boundary, and I would be interested to hear his thoughts on Sumner's proposal for NGDP targeting. He acknowledged that inflation expectations would be a way to get out of the liquidity trap, and proposed a 3-4% central bank target.

While he strongly believes in fiscal policy as a near-term solution, it obviously can't permanently finance the recovery, and a big increase in business investment is his preferred solution to move into a long-term higher growth. There's no obvious way to deliver that, although some solutions have been proposed.

Like yesterday's, tonight's lecture contained a couple of very well-observed points: first that the AD curve may slope upwards instead of downwards, in which case the conventional medicine of price reductions will not restore aggregate demand - and which casts doubt on my preferred assumption of sticky prices as a primary cause of recessions. And second, the mystery of why World War II permanently ended the Depression - when at the time, lots of people expected the slump to resume after the war ended. It may be explained by the rebuilding of balance sheets - household debt fell to about 20% of GDP during the war (I assume because households lent all their money to the government) which allowed borrowing to start again, and affected expectations of long-term demand growth, stimulating investment and firing up the dynamo of the economy.

In the throes of a recession I think we sometimes forget that growth is the economy's natural state. For all the mystery about its causes, there is no doubt that growth does happen and sustains itself. If market failures are fixed, there's every reason to expect that a recovery will become self-sustaining.

Krugman is concerned that the rest of the world now sees what Japan had in the 1990s: a "lost decade" where there is a permanent brake on growth. Even now there isn't a consensus on what that brake was or what lifted it, which makes it hard to know which market failure we would need to fix in order to unleash natural growth again. Perhaps I'll find out in the third of his lectures, tomorrow evening. Watch it live at the LSE's website and see if you can beat Bloomberg to the answers.

Update: part 2, my notes on the final lecture, is here.

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