My son says I’m a nerd. Maybe he’s right. When I heard that Paul Krugman, 2008 Nobel prize winner in economics, scourge of the Bush administration, op-ed writer for the New York Times, was giving three lectures at the LSE on our current financial crisis, I was thrilled. Krugman may not be the Cassandra of our economic debacle (that would be either Nouriel Roubini or the long dead Hyman Minsky) but his analysis remains head and shoulders above most academics—who still seem desperate to show that their failure to predict the popping bubble doesn’t prove the bankruptcy of orthodox theory.
I decide to go online the second tickets became available. Of course I don’t manage get to my computer until 12 minutes later and by then, all seats to all three nights are gone. Krugman proves to be a tougher ticket than Bruce Springsteen. I guess I’m not the only economics nerd in London. No worries, I think, I’ll get in on a press pass. I inveigle the editor of American Conservative (which for some reason, despite its right-wing name, seems happy to publish my musings on the perfidy of financiers) to request a press ticket. No go. No press tickets left. Even Prospect, who I tell I’ll blog for free if they get me in has no luck with the LSE press office. Somehow I sweet talk my way onto the reserve list and show up at 5pm, an hour and a half before The Professor is to speak, to try and worm my way in.
Already people are lined up. I ask Mahmud, a retired economics professor if he thought back in 2006 that the bubble would burst. He nods his head. He didn’t know when, of course, but he didn’t think the exuberance that Gordon Brown and Alan Greenspan had staked their reputations on would last forever. “You don’t need Keynes,” he tells me, “just common sense.”
At 6:40 Krugman mounts the stage. I manage to slip into a seat in the back row, next to two young women from Central Bank News. He starts by noting the obvious: we are in trouble. World industrial output has already fallen as far as it had at an equivalent stage in the great depression and world trade has fallen even more steeply. This wasn’t supposed to happen. We thought we knew better. Economists for the past 30 years were confident they had figured out a simple foolproof tool to avoid economic slowdown: monetary policy.
Milton Freidman taught us the Fed caused the 1930s depression by tightening the money supply. So any time unemployment seems a bigger problem than inflation, cut interest rates, goose the money supply and—bada bing!—the economy responds to the shot of adrenaline and production picks up. It seemed all so simple that ambitious macroeconomists stopped thinking about the business cycle. No glory thinking about recession when the solution is so straightforward. By cutting interest rates, you increase the desire for investment, decrease the desire for saving, thus increase aggregate demand and the recession is history.
But Krugman tells us the current situation demonstrates the Achilles heel of monetary policy. Short-term rates are already at zero and still the economy is falling. This is the problem of what he calls the “zero lower bound.” You can’t cut interest rates below zero even though that is what you would have to do to get desired savings and desired investment in line.
According to the US Federal Reserve today, to equalise worldwide savings and investment and to get us to full employment the interest rate should be negative 5 per cent. This, of course, is impossible and so monetary policy becomes pushing on a string. The Fed has tried, heroically, to increase the money supply. It has tripled its balance sheet and doubled the monetary base (currency plus bank reserves) but this has had a negligible effect on the broader money supply. The increased monetary base (the only part of the money supply directly under the control of central bankers) is not spreading throughout the economy but rather languishing in the vaults of banks.
As each of us, fearing economic turmoil, restricts our spending and increases our savings, we embody the paradox of thrift: that which is sensible for each of us individually becomes pernicious for us collectively. Spending decreases, as does incentive for investment. Why invest in increased capacity if nobody is buying the stuff you already produce? Even as the government ramps up its spending and borrowing, the private sector has cut its borrowing even more.
Krugman emphasises that government borrowing is in no way crowding out private borrowing. Indeed, by stimulating the economy, government deficit spending may actually provoke more private investment. But our problem today is over-supply of saving relative to desired investment. Thus government deficit spending is part of the solution.
He ends Monday’s lecture with a slightly optimistic thought: “Things seem to be getting worse more slowly.” However, he doesn’t think a robust and rapid recovery likely and suspects the world economy may stagnate for years; even that Japan’s “Lost Decade” may well feel swift by comparison.
We stream out happy, stimulated, if a tad more worried about our employment prospects. The Professor puts on a good show. Tonight at 6:30 he gives part 2: The Eschatology of Lost Decades—a look at the causes and possible cures for the financial crisis. Please don’t show up at the Old Theatre at LSE looking for a ticket. You might be taking my seat.