Wow -- what an amazing discussion. What I take from all this is that while fast action is the first priority, we need to be thinking, hard, about what comes next. We want to do better than FDR at fighting an economy that wants to go into depression; but we also want to figure out why so much went right under Harry Truman, so that the WPA didn't have to be resurrected.

I think there's another book waiting to be written ...

Meanwhile, thanks to everyone who weighed in on this terrific discussion.

For the medium to longer term, we need to put into place policies that will encourage sustainable economic growth. Here I discuss 8 important areas for reformulation of policy.

1. Green Policy: Economic sustainability will require more attention to the environment. This is an area that Obama has already identified as important, and I have no special expertise here. I would simply caution that economic recovery could reverse the course of oil prices (likely back toward $80 per barrel). Some combination of pressure on our oil producing "friends", subsidies for alternative energy and conservation, and energy costs relief for low income households will be needed.

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In the final chapter of his The Return of Depression Economics, Paul Krugman offers advice as to how the United States should address the deepening economic recession it finds itself in. Paul does so with a degree of pessimism about the likelihood that his advice (or policies consistent with it) will be adopted that is unwarranted.

Paul lays emphasis on the need to bring "good old-fashioned demand-side macroeconomic" to bear on the current crisis, "but its defenders lack all conviction, while its critics are filled with passionate intensity."

I would say instead that its defenders are busily designing a stimulus package likely to be five or six times the size of last year's and by far the largest in absolute terms in U.S. history. Meanwhile, many of its critics, including some politicians who agreed this fall that our economy is fundamentally sound, will be out of a job next Jan. 6 when the new Congress is sworn in.

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Dean Baker says that Alan Greenspan should have used his public appearances to warn people about the stock and housing bubbles, and if he had, the bubbles would not have inflated to such dangerous levels.

I don't have any problem with Dean's suggestion that talk matters. I'm not sure Greenspan could have been convinced there was anything more than "froth"; in housing markets, and that's part of the problem with this approach, and one reason why

I like rules that move against rising asset prices automatically rather than relying upon the discretion of Fed officials. But if somehow Greenspan had been convinced that a dangerous bubble was developing, and he was confident that he was correct in this assessment, sure, he should have sounded the warning.

But what if he was wrong about whether there was a bubble (and he was)? What good does it do to have the Fed chair saying there's no problem, go take out a variable rate mortgage and live happily ever after? With all of Dean's criticisms about economists missing bubbles, why is he confident the next time will be any different? And who will believe the Fed chair the next time anyway given how wrong Greenspan was? That's another reason I prefer rules that move against prices automatically, they don't require that people doing the talking be believed.

But my main problem with this approach comes with the implicit suggestion that one person, the Fed chair, should hold so much power within the Federal Reserve system, that it was Greenspan's job alone to sound the warning.

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One of the most novel and provocative assertions that has appeared in this week's Book Club forum was made Tuesday evening by Randall Wray in Stability is Destabilizing, as follows:

Those familiar with macro accounting recognize that the nongovernment sector balance must be equal to the government sector balance (sign reversed). If the government runs a budget surplus, the nongovernment must run a deficit of the same size. The Clinton government surplus sucked income and net financial wealth out of the private sector--leading to the Bush recession. That is not something to be wildly celebrated and emulated as fiscally responsible policy. Thank goodness that "Rubinomics" will not be adopted by the new Obama team.

When governments run deficits, they spend more than they take in; that is, they borrow, diverting private saving into public consumption. Because private saving is diverted to support public consumption, the private saving cannot underwrite private investment. That is why public deficits reduce the long-term growth of capacity -- when they occur under conditions of full employment, as they did in the late 1990s. Surplus spending or, more accurately, fiscal policy that increases the surplus or reduces the deficit, contributes to the growth of national economic capacity.

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Now that economists have finally discovered that asset bubbles can be harmful (next week, they learn about the shape of the earth), we are getting a debate about how to deal with them. I'm sure that this debate can provide full-time work to hundreds of economists, but at the risk of sending some of my colleagues to the unemployment lines, let me suggest a simple solution: talk.

Economists seem to hold a bizarre view, that it is both very important that people like Fed chairs and Treasury secretaries be careful about what they say, but also that what they say does not really matter. While such contradictions are standard for the economics profession, I will argue that what these folks say can really matter.

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Here is my wish list of policies. First we will need a comprehensive package of policies to deal with the immediate crisis. Here I will not delve deeply into the causes of the financial meltdown--interested readers are referred to my Policy Notes and Policy Briefs at www.levy.org, which foresaw and then analyzed the processes that created a "perfect storm" (the title of a piece I wrote in 2000--perhaps a wee bit prematurely?). It is, however, necessary to remember that "stability is destabilizing"--successful resolution of this crisis and restoration of a semblance of stability will encourage a return to risky practices. That is why we also need a package of policies for the medium- and longer-term. While we can never go back to the New Deal institutions and regulations, we can certainly learn from them. Recall that we did have quite a long run of good times after WWII, and Roosevelt's New Deal had a lot to do with that. The unraveling of the social and economic fabric over time--partly in response to deregulation but mostly due to "natural" profit-seeking behavior of innovative firms--created conditions in which "It" (a debt deflation and possibly a depression) became possible again. Hence, what we want to do is to promote institutions, regulations, and practices that can constrain modern capitalism's inherent thrust to fragility.

Originally I had planned to put all of this into one post, but due to length I have decided to devote Part One to the current crisis, and Part Two to the longer-run.
(And sorry for the back-to-back posts; I'm on Oz time and I guess the rest of you are asleep on USA time.)

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Paul Krugman has noted that we all seem to be "big government types"--recalling Nixon's statement that "we're all Keynesians now"--but we have not yet addressed whether our nation can afford a big government.

News reports today indicate that some on the Obama team are backing off on the size of the promised stimulus--to something less than $850 billion. I suspect that a big part of the reason can be attributed to Rubinitis (better known as deficit-phobia). Why, in the face of the biggest economic catastrophe this nation has faced since the 1930s, would Obama lose his courage? The three "eyes": Inflation, Investment crowding-out, Insolvency. I will try to calm those fears.

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Brad's definition of non-depression economics gives us a set of policy beliefs that "is no longer sufficient doctrine for our age," but he doesn't tell us why it is no longer sufficient, or what the new doctrine should be.

One reason the doctrine is no longer sufficient is that it has not been able to prevent the development of large asset price bubbles. And worse, as we are seeing right now, monetary policy cannot necessarily clean up the problems that occur when asset bubbles pop. The question, then, is how the doctrine can be updated so that it does a better job of preventing asset bubbles from developing.

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This discussion has so far one major lack: it does not tell us what "depression economics" is supposed to replace--it does not tell us what non-depression economics is, or was.

So let me try my hand at a definition of non-depression economics.

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Picking up on Paul's question about why we didn't go back into recession/depression after World War II (and following Randall's point), I think unions did play a very important role. Strong unions are a great mechanism for ensuring that workers will get their share of productivity growth. Workers are far more likely to spend their income than owners of capital or managers. Therefore the strong labor movement that came out of the organizing drives of the the thirties and the war was a powerful mechanism for sustaining demand growth.

Of course many economists have complained that strong unions are harmful for precisely this reason. The argument was that they raised costs and created inflationary pressure. Obviously there is some truth to this story, but clearly unions are an effective tool against the sort of deflationary spiral that we saw at the beginning of the depression.

This is something to keep in mind as Congress debates the Employee Free Choice Act next year.

Paul Krugman provides 4 plausible factors for the early postwar success: pent-up demand, baby boom, moderate inflation, and big government. To these I would add (again, in no particular order):

5. High wage/high consumption bias: strong unions pushed up wages, allowing growing domestic consumption based on income (not debt); this also promoted labor-saving innovation, technological advance, and all of that good stuff.

6. High government debt ratios/low private debt: we emerged from WWII with private balance sheets stuffed full of very safe government debt; in Minsky's terminology we had a "robust" financial sector with highly liquid assets (note this also is related to Paul's "pent-up demand" point).

7. External markets for US output: thanks to the Marshall Plan that provided the financial where-with-all to purchase US exports (as well as some destruction of productive capacity in war-torn Europe and Japan), the US could sell abroad.

8. Government spending "ratchet": government spending grew faster than GDP, supplementing private sector demand and thereby keeping labor, plant, and equipment operating near to full capacity.

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How does the massive expansion of the public sector in the aftermath of WWII "prove" the secular stagnationists wrong? "Once there was full employment .."

Full employment was not conjured out of a magician's hat. It was the result of deliberate growth of the public sector. How to kill one bird with two stones.

Exclude women from employment and build suburbs. Use the GI Bill to help veterans buy houses. Suburban housing creates commuters. Commuters need highways. Highways create demand for giant gas guzzling cars with fins (and those very cool glow-in-the-dark space ship dashboards). All those houses need refrigerators, dishwashers, washers, dryers, and vacuum cleaners and a mind-boggling array of NEW! IMPROVED! cleaning products.

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Since all of us in this discussion seem to be big-spending types of guys, a lot of our discussion has been about what comes after-- about when and whether the economy can stand on its own. There are, I think, two historical models for this. On one side, World War II put a definite end to the depression economics of the 30s. On the other, Japanese stimulus efforts helped the economy while they were on, but it's not clear that they ever provided a long-term solution.

So here's a question I haven't seen discussed (I'm sure someone has, but I haven't seen it): why did WWII "work", why did it prove the secular stagnationists wrong?

I can think of several possible reasons. In no particular order:

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What is going to be the new leading sector? What is going to allow us to maintain full employment without running huge long-term budget deficits that will, eventually, sap our rate of economic growth somewhat?

If it weren't for the fact that the furshlugginer dollar refuses to fall in value, the answer would be obvious: we will have a boom in import-competing manufacturing (and exports). But then the rest of the world has a long-run problem: if we decide to no longer be the world's importer of last resort, than what serves as a locomotive to keep it near full employment?

But if the dollar doesn't fall, then we have a long-run problem. The only answer I can think of is for the U.S. to then become the world's largest private-equity fund: they lend us their money, and we then invest the money back in their economies--in industries and companies that then have a very high demand for U.S. high-tech goods and for U.S. services exports.

I do not think that Paul Krugman should apologize for recognizing the canary in the coal mine back in 1997-98. Hyman Minsky saw this coming as early as the late 1950s. To the extent that we really did have a "great moderation", it would have fueled the longer-run transition toward fragility that had been developing over the entire post-war period. Indeed, 1996 saw for the first time ever persistent private sector deficit spending (taken as a whole, American firms and households were spending more than their incomes). This continued without let-up through to 2008 (with a brief respite during the depths of the Bush recession). So I do think there was something to the claims about a "great moderation"--in that there was an absence of fear that helped to generate debt-fueled bubble after debt-fueled bubble--although those promulgating these claims never understood the true ramifications. All of that was building toward what Minsky called "It" (as in "Can 'It' Happen Again?", the title of an early 1980s book that collected his essays): a Fisher-type debt deflation process. Some have called this current crisis the "Minsky Moment", but actually it is more accurate to recognize this as the culmination of the "Minsky Half-Century".

Turning to the other side of the private sector deficits coin, we find the Clinton budget surpluses. Of course these were widely proclaimed as beneficial (supposedly enhancing our future ability to take care of retiring baby-boomers--particularly ironic as we now watch our pension funds disappear). Those familiar with macro accounting recognize that the nongovernment sector balance must be equal to the government sector balance (sign reversed). If the government runs a budget surplus, the nongovernment must run a deficit of the same size. The Clinton government surplus sucked income and net financial wealth out of the private sector--leading to the Bush recession. That is not something to be wildly celebrated and emulated as fiscally responsible policy. Thank goodness that "Rubinomics" will not be adopted by the new Obama team.

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Participants in this discussion share the view that the toughest choices facing policy makers are imposed by the clock: how quickly can government spending flow into the economy thereby propping up demand, and slowing the rate of business collapse, while making the economy cleaner, greener, and fairer too.

The views expressed earlier in this discussion are that serious errors of theory and policy led to the belief that depressions had gone the way of the dodo bird. Yet, many of my colleagues in economics--with views dismissed by the academic establishment, rejected by policy makers, and ignored by the press--never bought into the idea that monetary policy and tax cuts would banish economic crises. The profession's surprise at the current disaster shows us just how well economists understand the real world.

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Paul Krugman is trying to get us to understand that depression economics is different from the economics of good times, that "normal rules don't apply."

Let me try to illustrate this point by looking at some objections to depression economics policy measures, in particular two recent objections to fiscal policy.

Tyler Cowen says that when it comes to fiscal policy, new research shows that deficit financed tax cuts are far more powerful than increased government spending at stimulating the economy.

But when I read the paper, I didn't think the results applied to depression economies because of the following sentence:

Furthermore, we find that deficit spending weakly stimulates the economy, that it crowds out private investment...

As I'll explain below, it's the claim of crowding out that raised red flags for me.

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I love the prospect of secular stagnation (raised by Bob Reich) primarily because the answers are so easy. :Let's keep our eyes on the ball. The problem in this picture is that we are capable of producing more goods and services than we want to consume. It's a problem of too little money chasing too many goods and services.

Well, there are two really simple answers to this problem:

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Bob Reich raises an important question that's been worrying me: what does the end game look like? When, if ever, can the economy throw away its crutches and do without big stimulus? I'm not sure I agree with his answer, but my own answer raises some awkward issues, as I'll explain in a minute.

Basically, what's happening now is that the things that supported our economy in the middle years of this decade -- high consumer spending relative to income and a housing boom -- are gone, and won't come back for the foreseeable future. So what will take their place?

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Paul Krugman writes:

[M]y main answer to Brad's question is that the events of 1997-1998 were, for me, a wake-up call. Before then I'd taken it for granted that central banks could always pump up demand, but Japan showed that the liquidity trap was a very real danger in a world in which inflation rates were fairly low.... I'd also assumed that bank runs were a thing of the past, but the Asian and LTCM crises showed that events functionally equivalent to bank runs could happen even if depository institutions - the denizens of big marble buildings with "FDIC insured" signs in their windows -- were protected. So I didn't take much comfort in the fact that a makeshift, cobbled-together set of measures managed to contain the crisis; it seemed all too obvious that the next crisis could be too big for improvisation to handle...

So what, in the long run, should the new regulatory and management system consist of?

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Paul Krugman writes:

My first answer is that the 1998 crisis was not, in fact, resolved all that easily. Bear in mind that there were really two crises: the high-speed capital-flight crises of Southeast Asia and the prolonged Japanese slump. The capital-flight crisis did subside quickly -- although even there it left permanent damage (Indonesia, with a bigger population than all the other crisis countries combined, has never recovered to its old growth track.) But Japan's woes went on and on. And Japan was the clearest omen for the United States...

Touche...

Brad DeLong asks a very good question: why did I see the 1998 crisis, which by some measures ended fairly quickly, as an omen of much worse to come; and why was 2008 so much harder to deal with?

My first answer is that the 1998 crisis was not, in fact, resolved all that easily. Bear in mind that there were really two crises: the high-speed capital-flight crises of Southeast Asia and the prolonged Japanese slump. The capital-flight crisis did subside quickly -- although even there it left permanent damage (Indonesia, with a bigger population than all the other crisis countries combined, has never recovered to its old growth track.) But Japan's woes went on and on. And Japan was the clearest omen for the United States.

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The exhortation to "spend, spend, spend" willy-nilly is not only absurd on its face -- why build pyramids, or bombs, when you can build bridges, or, still better for stimulus purposes, increase unemployment benefits? It also runs the risk of abusing the public trust insofar as it lacks accountability. Take the Troubled Asset Relief Program (TARP), for example. TARP, the $700 billion economic recovery package, is the single-largest expenditure authorized by Congress in one bill ever, in absolute terms. The lack of transparency regarding how these taxpayer dollars are being spent threatens to corrode the already diminished public trust and could impair the ability of the government to respond commensurately with the magnitude of crises and threats in the future.

Addressing this problem should be at the top of the agenda when the new Congress convenes next month.

Many people, from lawmakers on Capitol Hill to citizens around the country, have expressed frustration and disappointment that they cannot get more than cursory information regarding transactions executed to date pursuant to the TARP legislation. Even more dismaying is widespread confusion about what strategy the Treasury Department is following in making its transactions. Furthermore, many have serious concerns about the possibility that taxpayer money is being used for bonuses, golden parachutes, dividends, stock repurchases, etc., that is, in ways not contemplated when Congress passed the TARP legislation.

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Depression Economics begins with a discussion of the overconfidence
economists had in their ability to stabilize the economy during the period known
as The Great Moderation. Overconfidence in our abilities is a mistake economists
seem to be prone to making, and the book recalls the 1960s when, after the
discovery of the Phillips curve, "economists were holding conferences with
titles like 'Is the Business Cycle Obsolete?'" The volatile 1970s took care of
that attitude, and should have cured us of the tendency to be overconfident for
good, but it didn't. With the decline in the volatility in output and the taming
of inflation after 1984 - the period known as The Great Moderation - we found
Robert Lucas proclaiming in 2003 that the "central problem of
depression-prevention has been solved for all practical purposes.

Some of that confidence has, of course, eroded away as the current problems
the economy have unfolded and policy appears powerless to do anything about it.
It feels like watching a slow motion train wreck and being unable to do anything
about it. But the question I want to ask is whether overconfidence in policy is
responsible for our current predicament. I think the answer is yes, in part, but
I believe it is actually underconfidence in policy that has been the
bigger problem.

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Paul is correct in arguing for a large stimulus. I can't help wondering, though, if we'll need something more. Keynesianism is based on two highly-questionable assumptions in today's world. The first is that American consumers will eventually regain the purchasing power needed to keep the economy going full tilt. That seems doubtful. Median incomes dropped during the last recovery, adjusted for inflation, and even at the start weren't much higher than they were in the 1970s. Consumers kept spending by borrowing against their homes. But that's over. The second assumption seems even more doubtful: that, even if middle-class Americans had the money to continue the old pattern of spending, they could do so forever. Yet the social and environmental costs would soon overwhelm us. Even if climate change were not an imminent threat to the planet, the rest of the world will not allow American consumers to continue to use up a quarter of the planet's natural resources and generate an even larger share of its toxic wastes and pollutants.

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Dean Baker wrote:

Several Bush administration officials have suggested reducing mortgage interest rates to 4.0 percent, or possibly lower, with the intention of boosting the housing market. While there are markets in which it would be reasonable for the government to intervene to prevent a downward spiral of house prices, it is difficult to see anything good that would come from delaying a full adjustment in the markets that have still yet to fully deflate.

If extraordinarily low mortgage rates can succeed in preventing prices from falling back to trend levels, then house prices in these markets will presumably plummet when the economy recovers and mortgage interest rates return to more normal levels...

I disagree.

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This is a tough situation. I don't want to just parrot Paul Krugman, but I find it hard to disagree with much of what he has to say in this book.

So, I will take a slightly different tack. Paul is absolutely right that we must spend big time right now. This is a situation in which, to refer back to Keynes, completely wasteful forms of spending would be better than no spending at all. We must generate demand, and in this respect paying people to dig holes and then fill them up again is better than doing nothing.

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Let me ask Paul two related questions:

Paul, you wrote the first version book a decade ago, back when you were worried that the East Asian financial crisis of 1997-8 was a dying canary in a coal mine, a reflection not of faults in the Asian model but rather a sign that the old business cycle malady that we thought was controlled by monetarist eurythromycin was gaining immunity. But the East Asian financial crisis of 1997-1998--although sharp--was quickly cured (i) once the International Monetary Fund realized that the crisis was not one to be cured by administering painful medicine to governments, (ii) once the U.S. Treasury was freed from the fetters that Alfonse D'Amato and Bob Dole had imposed on it, (iii) once the IMF and the U.S. Treasury understood that their role was that of a lender-of-last-resort, and (iv) once Bob Rubin had bailed the big New York banks into Korea. The old monetarist eurythromycin seemed to work pretty well.

So, first, why did you back in 1998 think that the business cycle malady had developed some immunity?

And, second, why now does it seem as though the business cycle malady has developed some immunity?

Hi everyone. So, a few words about my new book, The Return of Depression Economics and the Crisis of 2008.

This is a heavily revised new edition of The Return of Depression Economics, originally published 9 years ago. When I wrote the original version, I had Asia on my mind. Some people looked at the crisis that swept Southeast Asia and at Japan's monetary trap, and saw them as proof of the superiority of the American system. I looked at the same things and saw them as omens. I worried that similar things could happen to us. And now they have.

Right now the world economy is in a nosedive, and understanding what I call "depression economics" -- the weird world you get into when even a zero interest rate isn't low enough, and a messed-up financial system is dragging down the real economy -- is essential if we're going to avoid the worst.

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