Depression Economics in the time of corona

Reading Paul Krugman’s books on “Depression Economics” in these corona times might not seem like a terribly original idea; it might even seem like self-flagellation. Well, I didn’t get there by deliberate choice. I was dusting my bookshelf to put the lockdown to good use and “discovered” a couple of Mr Krugman’s books in the back row. I started browsing through them, and eventually ended up re-reading them.  It turned out to be a rewarding experience notwithstanding the dismal subject and the dismal times we are now enduring. Was my sense of time well spent because the author is considered among the smartest dismal scientists of our time? Because he communicates complex ideas in a lucid, lively style? 

Both those reasons for sure, but perhaps a more weighty one too. Mr Krugman’s subject matter is the many financial crises the world has seen in the 90 years since the Great Depression of the 1930s. All of them originated in the financial sector and every one of them was a consequence of irrational exuberance and reckless risk taking. And every one of them had to be resolved through financial sector policies. The current crisis, in contrast, is a consequence of a cause outside the financial system, and a lasting solution has to come not from financial sector polices but from science. Notwithstanding that big difference, re-reading Mr Krugman has helped me get new perspectives on some of the debates we are having as we navigate this crisis. But before I get to that, let me give a synopsis of his “depression” books.

The first one in my collection is his 1999 book, The Return of Depression Economics, in which he decries the triumphalism of the economics profession that the central problem of depressions has been solved, that between John Maynard Keynes and Milton Friedman, economists now knew enough to prevent scary slumps like the Great Depression. For declaring victory too soon, economists got a brutal rebuke via the string of financial crises in the 1990s, including importantly, the ruinous Asian Crisis towards the end of that decade. Mr Krugman warned that like diseases which had become resistant to antibiotics, the economic maladies that caused the Great Depression were making a comeback.

In the event he stood vindicated. A bubble in the US subprime housing market snowballed into a once-in-a-generation financial crisis and brought the global financial sector to a near-death experience in 2008. Being at the helm of the Reserve Bank of India during that turbulent period, I can recall how scary it was in real time; a replay of the Great Depression seemed all too possible. This scenario forms the platform for Mr Krugman’s follow-up book, The Return of Depression Economics and the Crisis of 2008  where he derides the hubris of economists who thought that financial crises were only an emerging market phenomenon. Mr Krugman’s central thesis that runs through both these books, and indeed through his influential weekly column in the New York Times,  is that in a financial crisis, the government should throw the rule book out, boldly spend more, if necessary by printing money. To buttress his argument, he invokes, to great effect, Keynes who said, “The boom, not the slump, is the time for austerity.” And to illustrate the magic of money printing, he uses the analogy of a babysitting cooperative in Washington DC which I found interesting but not entirely persuasive. 

That provides the context for me to segue into a big debate we are having here at home on whether India can spend its way out of this crisis by resorting to print and spend policies. Wouldn’t the market penalise us for fiscal excess? One view is that it would not — that in a synchronised downturn where every country is breeching fiscal limits, the rules of the game should be more lenient. Given the emergency, the government should act as if there were no constraint, borrowing and spending as needed. 

Unfortunately, no emerging market can take the generosity of the markets for granted. Why indeed not? We find an answer in Mr Krugman’s books. In the build-up to the Asian crisis in the late 1990s, Australia, a rich country, and the Asian economies, all of them emerging markets, had a similar build-up of risk. But the markets allowed Australia to make a smooth adjustment and avert a crisis, while they denied a similar privilege to the Asian economies and landed them in a devastating crisis.

The short point is that markets are much less forgiving of policy excesses by emerging markets compared to rich economies. But that is so unjust? Indeed it is. Maybe another column, another time to ponder over that question. 

Meanwhile, dusting the bookshelf still remains there, right on top of my “to do” list.

(The writer is former  governor of the Reserve Bank of India) 

Pandemic Perusing is an occasional freewheeling column on books and reading by our writers and reviewers