A Brief Critique of The Return of Depression Economics and the Crisis of 2008

Paul Krugman is a New York Times bestselling author and winner of the Nobel Prize in economics. His is also a syndicated columnist for the New York Times and former advisor to Enron. In his most recent book, The Return of Depression Economics and the Crisis of 2008, Krugman revisits his 1999 publication while expanding upon his theories to meet the economic recession of 2008-2009. Specifically, Krugman targets lax regulation in the financial system as the root cause in the U.S. economy’s most recent crisis. He warns that without taking proper measures, our economy could plunge back into the dark days of depression.

Krugman’s book begins with the subject of his first edition of The Return of Depression Economics, the economic crises in Latin America and Southeast Asia. He uses these examples, coupled with a general explanation of the Great Depression to point out that many of the problems faced by international economies have not, in fact, improved much since the 1930s. Krugman goes on to argue that the 2008 financial crisis in America draws many similarities from the international meltdowns from a decade before. By the mid 1990s Japan had been experiencing enormous growth along with sky-high land and stock prices. This financial bubble, Krugman claims, is eerily similar to the housing bubble in the U.S., where the cost of subprime loans surpassed the values of the homes. The author also believes that we are in a “liquidity trap” that is stemming the flow of capital between countries. On the same token, U.S. firms that were once too highly leveraged have now sold their assets in order to raise money and further pushed the markets into recession.

Krugman’s main argument seems to center around the case of shadow banking. Krugman maintains that any entity acting as a bank should be regulated as a bank. If this had been the case, the housing crisis and subsequent recession would not have occurred. Here Krugman makes an interesting point. Perhaps the author is correct – that not enough regulation led to many of our current problems. On the other hand, it seems to me that in some cases the best way to prevent such massive failures is to take away the incentive behind high risk lending and borrowing. By allowing high-risk taking firms to fail, the government is sending a clear message that this kind of policy will not stand, much less be condoned by the fed.

My main issue with Krugman is that his policy advices come too far after the fact. By the time of his publication (December 2008) I think it was clear that large financial firms were operating under too little regulation. The question now is how much and where this regulation should be placed. Perhaps the best idea for mitigating the risk of massive financial failure comes from former chairman of the Federal Reserve, Paul Volker, who argues that financial firms should separate their commercial banking and investment banking into two distinct entities.