Must-Read: Paul Krugman: Did The Fed Save The World?
Must-Read: Looking back at my archives, I find that my own ratio of “Paul Krugman is right” to “Paul Krugman is wrong” posts is not in the rational range between 10-1 and 5-1, but is 15-1. So I am looking for an opportunity to rebalance. And I find one this morning: Here I think Paul Krugman is wrong. Why? Because of this:
Housing crashes. And does not bounce back quickly by the end of 2010–or, indeed, at all. And Paul Krugman is correct to write that “Even a total collapse of home lending couldn’t have subtracted more than a point or two more off aggregate demand”:
But exports collapse as the financial crisis hits, and then bounce back very rapidly as the financial crisis passes:
And roughly one-third of the financial-crisis associated collapse in business investment is quickly reversed after the financial crisis passes:
Together these two factors plausibly associated with the reuniting of the web of financial intermediation look to me to be five times as large as the fiscal stimulus measured by government purchases. Now fiscal stimulus worked through channels other than government purchases. And without the Recovery Act we would have seen states and localities not holding their purchases constant over 2008-2011 but cutting them by 1% of GDP or so. And not all of the export and business investment bounce-back in the two years after the 2009 trough can be attributed to lender-of-last-resort and easy-money policies.
But it looks to me like the balance is that–even with housing left to rot on the stalk–monetary and banking policy did more than fiscal policy to stem the downturn and promote recovery up to 2011. And it looks to me that, since 2011, it is the reknitting of the financial system and easy money that has kept the extraordinary austerity that the states and the Republicans imposed and that Obama has bought into from sending the U.S., at least, into a renewed and deeper downturn.
: Did The Fed Save The World?: “Bernanke’s basic theme is that the shocks of 2008 were bad enough that we could have had a full replay of the Great Depression…
…the reason we didn’t was that in the 30s central banks just sat immobilized while the financial system crashed, but this time they went all out to keep markets working. Should we believe this?… I very much agree with BB that pulling out all the stops was the right thing to do…. But I’m not persuaded that the real difference between 2008 and 1930-31 (which is when the Depression turned Great) lies in central bank action, or related bailouts. It’s true that the 30s were marked by a big financial disruption…. Shadow banking rapidly shriveled up, with repo and other alternatives to bank financing shrinking very fast; liquidity for everything but the safest of assets disappeared even though the big financial firms remained in being. And if we’re looking for effects of the tightening in credit conditions, remember that credit policy usually exerts its biggest effects through housing — and housing investment fell more than 60 percent as a share of GDP….
So really, was putting a limit on the financial crisis the reason we didn’t do a full 1930s? Or was it something else? And there is one other big difference between the world in 2008 and the world in 1930: big government…. Again, Bernanke and company were right to step in forcefully. But I’d argue that the fiscal environment was probably more important than monetary actions in limiting the damage. Oh, and since 2010 officials everywhere, but especially in Europe, have been doing all they can to undo the favorable effects…. And the result is that in Europe economic performance is at this point considerably worse than it was at this point in the 1930s.