New crisis, old-time remedy

A decade ago, Paul Krugman wrote a little book warning us that economists' triumphalism was misplaced -- that advances in economic knowledge and economic policy had not, after all, banished the prospect of big depressions from the global economy. "The Return of Depression Economics" sank with barely a ripple. After all, the East Asian financial crisis of 1997-98 -- although sharp -- was short and quickly cured once the International Monetary Fund realized that the crisis was not the fault of governments and once Senate Republicans allowed the U.S. Treasury to intervene in world markets. Japan's economic problems during its lost-growth decade of the 1990s were, economists asserted, peculiar to itself. And the collapse of the dot-com bubble in 2000-01 brought on not a depression but merely an output decline so mild as to barely warrant the name "recession."

Now Krugman is back, armed with a Nobel Prize for economics and a crisis that is orders of magnitude worse than the East Asian one. And he is back with more than a second edition in "The Return of Depression Economics and the Crisis of 2008." He returns with a stronger argument, as the current financial crisis serves as a third example, alongside Japan's lost-growth decade and the East Asian crisis, of "depression economics."

His thesis makes me want to say "no" and "yes." No, Krugman is wrong when he worries that the disease of the business cycle "long . . . considered conquered . . . had reemerged in a form resistant to all the standard" remedies. The standard remedies still do work. Yes, he is right in his claim that "depression economics" is very relevant to economic discourse and policymaking today -- for it is only by knowing depression economics well that we can figure out which of the standard remedies is likely to be effective in any particular case, and how strong a dose will be needed.

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If liquidity is king

What is "depression economics"? Cast yourself back 500 years ago to the docks where Antonio, the merchant of Venice, is loading the goods for a venture onto one of his ships: the spices of the Indies, the silks of Cathay and the intoxicants of Araby. But in order to carry out his venture, he needs investors: Shylock, say. Suppose that the morning comes to set sail and Shylock balks -- says that he needs his money now to pay for the wedding of his daughter or that the venture is too risky and he wants to keep his wealth close at hand.