Krugman, from crisis to the other

In 1999, Paul Krugman analyzed, in The Return of Depression Economicsthe causes and consequences of Mexican, Asian, Argentina, Russian or even Japanese marasm. The current financial crisis earned us the pleasure of an increased reissue of several chapters dealing with the 2007/2008 financial crisis.

The first half of the book dissects the crises of the 1990s, characterized especially by defects of sovereign debts or violent – and often excessive – prices of currencies from emerging countries. Krugman returns to the difficulties that these countries experienced when, from the 1980s, the freedom of movement of capital had become an almost divine precept. Most emerging countries, notes the famous economist, would need both an independent monetary policy (because their economic cycles are not sufficiently correlated with those of the major monetary powers) and fixed exchange courses (to attract foreign investments and finance their debt at a reasonable and constant cost). These two options being incompatible with each other, each country, according to the options it retains, knows the crisis of its system. Hence the succession of crises of recent decades, whose scenario is always the same ; Emerging countries adopt fixed exchange schemes that do not explode.

We will thus find, in this small manual of crises, a coherent and supplied whole which gives some ideas to fight against financial crises and in particular to limit the consequences on the real economy. Krugman observes for example that if a currency is overvalued, it is useless for a state to try to defend it, because the exchange reserves of a central bank of a emerging country are generally lower than the resources mobilized by international financial actors to push for devaluation. In other words, therapeutic relentlessness is not a solution. We remember the attack as such “ coordinating By George Soros on his British pounds in the early 1990s, an attack which actually obtained devaluation. The adjustment by the exchange rate seems as much less painful than adjustment by wages and prices (which can take years) or that the increase in interest rates, often used to combat the drop in a currency but which reduces real activity.

Now classically, Krugman also recalls the incongruity of the recommendations of IMF In the 1990s, when the fund required increase in interest rates and lower public spending in the event of a crisis (Thailand, Indonesia, Korea 1997) ; Which in theory was to restore the credibility of a currency or a state in reality only worsened evil. He salutes the recent change in policy of IMFmaterialized in 2008 by the loans granted to Ukraine, Iceland, Hungary or Belarus, the authorization in this framework of the boost of recovery and a tolerance in stronger macroeconomic matters (the IMF has reduced the number and rigor of the conditions for countries in request for assistance). On the other hand, the gradual disappearance of Currency Boards Allows you to hope for less strong change of exchange for emerging countries.

Japanese experience

To decipher the current crisis, however, it is on the Japanese side that you have to look. The Japanese bugger is indeed not without resemblance to the shock collected by the United States and Europe since the summer of 2007. The inflation of the price of assets and the real estate bubble of the late 1980s in Japan has indeed resulted in over-indebtedness of households, the constitution of questionable claims in the portfolios of financial institutions, panics and banking bankruptcies … Interest rates (increased to 0% by the central bank) nor the multiplication of recovery plans (at the cost of considerable public debt) managed to energize. Krugman recalls the causes of these multiple failures, ranging from the lack of confidence of consumers, who save the purchasing power episodically injected by the government, including deflation anticipations, which lead individuals to postpone their purchases and businesses. Getting out of this liquidity hatch turns out to be particularly difficult, since this implies either to significantly increase consumption and investment, or to reduce the country’s debt level, or to stimulate inflation anticipations to prevent all economic actors to sink into widespread wait -by.

The risk that the United States faces today is that of entering this phase of deleveraging (The reverse lever effect) that Japan experienced, with households and businesses that no longer have confidence in the future and divest, alongside a state that multiplies recovery plans and increases its debt without being able to compensate for the lethargy of private actors. This risk is all the higher since in the United States, households have experienced two explosions of speculative bubbles, which have seriously grew their heritage. Today, the indebtedness of American households to acquire housing and the spectacular decline in the price of these make 12 million American households have a negative heritage. In addition, out of the $ 8,000 billion destroyed by the drop in the real estate market, around 7,000 will weigh directly on households and 1,000 on financial institutions. This “ Rich effect upside down It will therefore be particularly difficult to reverse.

On the other hand, if the American banking system is affected, it is nothing next to the crisis that the Shadow Financial System (financial institutions other than banks). Since the mid-1990s, credit has developed considerably outside banks in the United States, often escaping any regulation or application of any prudential ratios. And Krugman to list these poetics of the credit market which tanns or disappear. Almost half of the American credit market operates outside or on the sidelines of conventional prudential rules. The Fed, lending to the banks and lowering its refinancing rates, therefore solves only a small part of the problem of Credit Crunch. It is not at all obvious that a return of credit by banks is enough to compensate for the drop in mortgage, the drop in outstanding credit cards, etc. Observation of interest rates granted to SME or the rates of mortgage loans leaves Krugman (and us with) quite pessimistic (s) from this point of view.

All these elements invite to revive the economy in a massive way, because the point of GDP injected in 2008 in the United States is not up to the challenges exposed above. Krugman pleads for a plan of the order of 4 points of GDPby supporting the request by public spending. On the other hand, he is quite severe with the idea of ​​resting a recovery scenario on tax advantages given to companies or individuals, considering risky to subcontract the effective investment decision at a time when not investing is no longer an option. Among the debates on the nature of priority expenses, one can wonder, like Thomas Friedman, on the relevance of subsidizing the automotive industry, the consumption of hydrocarbons or the construction of roads without ecological condition (this last proposal being formulated by Krugman.

Finally, the last element of the debate relates to the sequences of a recovery plan and the need to include measures with immediate effect, to avoid the usual trap of Keynesian reminders: once slow measures (public investments) finally produce their effects on the economy, the situation is already starting up and the recovery plans are generally pro-cyclical. We can only regret that national recovery plans come so late, eighteen months after the start of the financial crisis, so that the field of recovery options is more or less reduced to choosing between measures with immediate effect but without much long-term effect (drop in VAT For example) or investments for preparing for the future, with the risk that their recovery effect is slow to materialize. Nevertheless, Krugman replies, the extent of this crisis suggests that it will last and that investment plans, concretized in mid-2009 or even in early 2010, will certainly arrive late but not too late.