23 Jan 2009

More Subtleties in the Claim that "Free Markets" Caused the Crisis

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Per Bylund passed along this video interview with Krugman. He blamed the present mess on 30 years of rigid free market ideology, and then clarified that the regulatory apparatus failed to keep up with the changing financial system. In case you’re curious, the reason he has to say it that way is that there was no smoking gun of “deregulation” that the critics can point to. The only possible candidate is the 1999 relaxation of Glass-Steagal. Obviously I can’t prove that this is untrue, but if you study what that change did, I find it highly implausible that it sparked a housing boom that didn’t really kick into full gear until a few years later, and also coaxed banks to make trillions in bad loans.

The other gem of the interview is Krugman saying this is the worst financial shock since 1931/1932, but that (paraphrasing) “hopefully our policy responses will be different this time, so we won’t get another Great Depression.”

I agree, Professor Krugman. In 1931 and 1932,* the policy response was to run an unprecedented peacetime budget deficit, to urge businesses not to lay off workers or cut wages, to engage in massive public works spending, and to bring the discount rate really low to help the financial sector.

Good thing we’re not making the mistakes of the past.

* I would have to double check the timelines, but my description might more accurately apply to 1930/1931. By 1932 the government and Fed started to realize that their Krugmanian medicine (not their term) wasn’t working and they started changing course, like jacking up taxes (to try to close the deficit) and raising the discount rate (to stem the outflow of gold). But clearly they tried Krugman’s policies for two full years after the stock market Crash and got the worst depression in history.

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