The one where Mr. I-just-got-dubbed-the-world’s-smartest-economist suggests that America needs a “full temporary nationalization of a significant part of the financial system”?

Which was considered radical back when mother-socializing SWEDEN did that in the 1990s?

If you haven’t read it, it lives here and ranges from quotations of Keynes (“we have magneto trouble“) to headlines in The Onion (“Recession-Plagued Nation Demands New Bubble to Invest In”).

In the print edition, it ran next to an ad for the show “Art and China’s Revolution” at the Asia Society in NYC:

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(It’s a portrait of Mao by Tang Xiaohe. That’s the biggest image I could find.)

More selected quotes (including Krugman’s insistence that “there is a free lunch, if we can only figure out how to get our hands on it”) below the jump.

My guess is that the recapitalization will eventually have to get bigger and broader, and that there will eventually have to be more assertion of government control—in effect, it will come closer to a full temporary nationalization of a significant part of the financial system. Just to be clear, this isn’t a long-term goal, a matter of seizing the economy’s commanding heights: finance should be reprivatized as soon as it’s safe to do so, just as Sweden put banking back in the private sector after its big bailout in the early Nineties. But for now the important thing is to loosen up credit by any means at hand, without getting tied up in ideological knots. Nothing could be worse than failing to do what’s necessary out of fear that acting to save the financial system is somehow “socialist.”

Even if the rescue of the financial system starts to bring credit markets back to life, we’ll still face a global slump that’s gathering momentum. What should be done about that? The answer, almost surely, is good old Keynesian fiscal stimulus.

Now, the United States tried a fiscal stimulus in early 2008; both the Bush administration and congressional Democrats touted it as a plan to “jump-start” the economy. The actual results were, however, disappointing, for two reasons. First, the stimulus was too small, accounting for only about 1 percent of GDP. The next one should be much bigger, say, as much as 4 percent of GDP. Second, most of the money in the first package took the form of tax rebates, many of which were saved rather than spent. The next plan should focus on sustaining and expanding government spending—sustaining it by providing aid to state and local governments, expanding it with spending on roads, bridges, and other forms of infrastructure.

“We have magneto trouble,” said John Maynard Keynes at the start of the Great Depression: most of the economic engine was in good shape, but a crucial component, the financial system, wasn’t working. He also said this: “We have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand.” Both statements are as true now as they were then.

How did this second great colossal muddle arise? In the aftermath of the Great Depression, we redesigned the machine so that we did understand it, well enough at any rate to avoid big disasters. Banks, the piece of the system that malfunctioned so badly in the 1930s, were placed under tight regulation and supported by a strong safety net. Meanwhile, international movements of capital, which played a disruptive role in the 1930s, were also limited. The financial system became a little boring but much safer.

What we’re going to have to do, clearly, is relearn the lessons our grandfathers were taught by the Great Depression. I won’t try to lay out the details of a new regulatory regime, but the basic principle should be clear: anything that has to be rescued during a financial crisis, because it plays an essential role in the financial mechanism, should be regulated when there isn’t a crisis so that it doesn’t take excessive risks. Since the 1930s commercial banks have been required to have adequate capital, hold reserves of liquid assets that can be quickly converted into cash, and limit the types of investments they make, all in return for federal guarantees when things go wrong. Now that we’ve seen a wide range of non-bank institutions create what amounts to a banking crisis, comparable regulation has to be extended to a much larger part of the system.

The quintessential economic sentence is supposed to be “There is no free lunch”; it says that there are limited resources, that to have more of one thing you must accept less of another, that there is no gain without pain. Depression economics, however, is the study of situations where there is a free lunch, if we can only figure out how to get our hands on it, because there are unemployed resources that could be put to work. The true scarcity in Keynes’s world—and ours—was therefore not of resources, or even of virtue, but of understanding.

Brend an Kiley has worked as a child actor in New Orleans, as a member of the junior press corps at the 1988 Republican National Convention, and, for one happy April, as a bootlegger’s assistant in Nicaragua....

14 replies on “Did Everybody Already Read and Get Over This Paul Krugman Essay in the New York Review of Books?”

  1. Well, Krugman suggests going for a lunch our kids and grandkids will pay for, but it won’t be free. Eric Jantzen had this fella’s number last year, when he predicted when this current bubble burst and caught everyone by such surprise, the best and brightest would push for a new bubble rather than vow to set the economy on a better footing. He predicted infrastructure/energy as the direction, and here we are. It was a Harper’s cover story – I think Jantzen has a PDF link up on the front page at iTulip.

  2. Nevermind the current crisis has a lot of roots in the “solutions” to the Great Depression…

    Or that Krugman is obviously going off the deep end; there is not, and will never be a thing such as a free lunch. Just one’s that are “cheaper” than others.

  6. @1, 2:

    Krugman’s been going over the lessons of the Depression on a daily basis on his blog for the last several months. There’s a lot to learn from that period, most notably that to the extent government spending was tried during the 1930s, it worked. The problem was that FDR was too timid until WWII broke out, after which military Keynesianism saved the national economy.

    The reason infrastructure spending is not likely to be a bubble is that we have decades of underinvestment, the rest of the economy is at a standstill, that investment produces jobs and long-term improvements in efficiency and economic growth, and the current deflationary trends mean that there’s a lot of room to act before there’s an inflationary response and our toolkit to deal with inflation if it does pop up down the road is well-equipped. It’s not the same as the real estate bubble, which was not related to any actual improvements in land, or the accompanying credit bubble, or the previous stock bubble which was an overreaction to real economic benefits from the information economy because capital had nowhere else to go.

    Right now we’re experiencing a 3.7% decline in prices over the last three months, or well over -13% inflation at an annualized rate. No one is going to lend money in that environment, and if no one lends that just continues the deflationary spiral. That leaves only the government to lend. There’s a risk of a bubble in t-bills to finance all the necessary borrowing, but on the other hand our national debt was twice as large relative to the economy in WWII as it is now. There’s still lots of room (as in multiple trillions) of fiscal stimulus left. We’re screwed if we do nothing because deflation and a collapsing economy will mean we won’t have enough money to even keep up with our current interest payments. We have to invest in the right things (not tax cuts or corporate giveaways) or else we’re going down. We might go down anyway, but history suggests the way out.

  7. @6 – Right, they call it a bubble because prices and trading are (increasingly) overinflated relative to tangible value. Eg., people are getting rich off no real production, so when the bubble pops, a lot of wealth has been lost and there’s nothing to show for it. The Bush years, in a nutshell.

  8. Krugman is right.

    Look, guys, it’s time for classic Keynesian approaches and throwing everything at the wall that might stick.

    As to money supply – if the GDP keeps dropping 2-10 percent each year for a decade it won’t matter that your currency didn’t devalue ….

  10. There is indeed a free lunch but it’s not the one you think – Read the article.

    And then project yourself out to our future of double digit unemployment. The free lunch comes from avoiding that future – by avoiding the massive waste that massive unemployment and institutional bankruptcy entails.

    It’s as if everyone you knew had a plan to take a quarter of everything they owned and dump it into the ocean – and then someone said – there’s a free lunch and it involves not taking that stuff and dumping it into the ocean. The win from not doing that is double – 1) everyone gets to keep that stuff (e.g. the productive work and companies that would otherwise die) and 2) you don’t damage the ocean (you don’t get all the collateral damage from having gangs of unemployed people wandering the country and losing the rest of your manufacturing base.)

    It’s not that complicated, but it is kinda important 🙂

  11. And the analogy would be a slightly better fit if the plan was for everyone to throw between nothing and everything they owned into the ocean (with the probability of your ticket or whatever coming up “everything” being higher the less you owned.)

    There – that horse is now suitably battered and deep fried

  13. Most people have overlooked Krugman’s advice to Obama: the lesson from the New Deal is that IT WASN’T AMBITIOUS ENOUGH.

    The New didn’t lead the country out of the depression because Roosevelt was hemmed in by Republicans, Segregationist Democrats, and a hostile Supreme Court. And because he was more of a progressive-era centrist than a socialist. So he backpedaled on his experiments, didn’t push them far enough, then tried to balance the budget in 1937-8 and undermined what little progress had been made.

    The only thing that rescued the economy was total war mobilization for WWII. Unless we want to “fix” our economy by completely militarizing it, we’ll need to find much more civic unity behind expansive government programs to safeguard our financial system and reconfigure the productive wing of our economy toward more environmentally sustainable practices.

    Or we could just be like WA Democrats, and put tens of thousands of people out of work and reduce enrollment in our schools in order to balance the state budget! I’m sure THAT will keep us out of a depression! Obama can’t rescue them from their own poor leadership, though they can hope…

    http://seattletimes.nwsource.com/html/op…

  14. “Free lunch”, possibly buried and rotting in a dump of ignorant inaction, was an inept and baggage-laden simile, given what Klugman seems to have meant.

    “Lunch hanging high up in the branches while we discuss the merits of ladders”, might have been more apt.

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