Monday, June 28, 2010

Excess Austerity and the Third Depression

Paul Krugman has an interesting Op-Ed in the New York Times, about the perspective of a double dip following the present austerity policies and transforming the 2007-2009 Great Recession in the Third Great Depression.

The current episode could prove to be the early stage of the third depression, probably looking more like the Long Depression, the years of instability and deflation that followed the Panic of 1873, than the much more severe Great Depression that followed the financial crisis of 1929-1931. Both included periods when the economy grew, but these episodes of improvement were followed by relapses.

Why it could happen today is because, after correctly allowing deficits to rise in a first phase, the governments are now obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending. Unemployment shows no sign of coming down rapidly anywhere, and both the United States and Europe are well on their way toward Japan-style deflationary traps.

The punch line: “In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.”

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