I think Paul has it right this time. Paul Krugman that is..
Let's Not Panic - Yet
By PAUL KRUGMAN
AMBRIDGE, Mass. -- Could the current craziness in world financial markets translate into a
global slump, maybe even a new Great Depression? Of course it could. The story might go
something like this: Over the next few weeks, investors, made jittery by the debacle in Russia, stage
runs on the currencies of many third world countries. The governments of these countries respond by
raising interest rates to 30, 50, 70 percent -- stabilizing their currencies but pushing their
corporations into bankruptcy, provoking devastating bank runs and plunging their economies into
deep recession.
Meanwhile, Japanese lawmakers are unable to agree on a plan to rescue the nation's dysfunctional
banking system. The result is a sharp drop in the yen, but Japan's central bank, declaring that a
strong yen is essential, defends the currency with higher interest rates, which sends Japanese industry
into a tailspin.
The direct effects of these developments on the United States and the European Union are relatively
small. But the dismal news undermines the euphoria that had driven Western stock prices to
hard-to-justify heights. As stocks fall, so does the consumer spending that had offset the drag from
Asia's collapse.
Despite all this, the Federal Reserve and the Bundesbank are reluctant to cut interest rates. The Fed
believes that the stock crash validates its earlier warnings that the market was driven by "irrational
exuberance" and -- like the Bank of Japan in the early 1990's -- welcomes the bursting of the
financial bubble. Meanwhile, the Bundesbank -- which will hand over the monetary reins to the new
European Central Bank in only a few months -- wants its successor to understand the importance of
sound money and stable prices, and is unwilling to blur that message with any hasty reflationary
moves.
Within a year or two, of course, it becomes clear that everyone has been far too cautious, and many
countries start trying to boost spending any way they can. But it is too late: self-fulfilling pessimism
has become so deeply embedded in the private sector that even zero interest rates and large tax cuts
are not enough to get the world economy moving again.
I hope you don't regard this scenario as a literal prediction of what is going to happen. For one thing,
real crises never play out according to the expected script. Anyway, this scenario, or any similar
scenario, is not all that persuasive. It requires not only that world financial markets be governed by
Murphy's Law -- that everything that could go wrong does -- but also that all of the major policy
makers play right into Murphy's hands. The odds are that at least a few things will go right, that
Japan will pass a halfway decent bank reform law, that the markets will take a deep breath and
realize that Brazil and Russia are, after all, rather different places.
Even if financial markets do continue to tumble, Alan Greenspan and his counterparts in other
advanced countries have the tools they need to prevent paper losses from turning into a slump in real
output. Mr. Greenspan turned a stock market crash into a real-economy non-event in 1987; he can
do it again.
But will he? That's where I start to worry. The real risk to the world economy comes not from bad
fundamentals but from rigid ideologies -- ideologies that might make policy makers fail to respond,
or even move the wrong way, if a global slump starts to develop.
One of those ideologies is the belief that a strong currency means a strong economy, that stable
prices insure prosperity. Notice that my scenario had the Bank of Japan actually raising interest rates
in a recession in order to defend the yen, and the Bundesbank refusing to cut rates because it doesn't
want to encourage laxity in its successors.
Both actions would be deeply foolish. Alas, given the strong-yen rhetoric of Japan and the
stable-price rhetoric of Germany, both are also quite plausible. In his classic book "Golden Fetters,"
Barry Eichengreen, an economist at the University of California at Berkeley, showed that the spread
of the Great Depression was, more than anything else, caused by the dogged determination of many
nations to remain on the gold standard at all costs. Nobody is on the gold standard these days, but
the urge to defend monetary purity, never mind the real economy, remains.
The other ideology might be summarized as "blaming the victim." Just listen to what one now hears
about Asia: that it shouldn't even attempt a quick recovery through monetary and fiscal expansion,
because it will only delay the correction of deeper structural problems. This admonition sounds like
an eerie echo of the famous advice that Herbert Hoover received from Andrew Mellon: "Liquidate
labor, liquidate stocks, liquidate the farmers, liquidate real estate . . .
purge the rottenness out of the system."
It is easy to imagine that effective action against a slump might come too little, too late, because the
initial stages of that slump are regarded not as danger signs but as just punishment for economic sins.
In the end, a global slump is quite an easy thing to prevent. The only way it can happen is if the
people who have the power to prevent it fail to take the risk of such a slump seriously, and continue
to cling to ideologies inherited from a more benign era. If Mr. Greenspan and his colleagues have an
appropriate degree of nervousness -- if they understand that while a replay of 1929 is unlikely, it is
possible -- then everything will be more or less all right. The only thing we need to fear is the lack of
fear itself.
Paul Krugman is an economics professor at the Massachusetts Institute of Technology. |
