Paul Krugman on What's Really Killing the World Economy

Turns out forgiveness can be a virtue when it comes to easing hard economic times, as well as other areas of life.


The world economy is still stumbling, Paul Krugman writes in his column today. Recovery is stalling. "If this story sounds familiar, it should; it has played out repeatedly since 2008," Krugman writes, somewhat depressingly. "As in previous episodes, the worst news is coming from Europe, but this time there is also a clear slowdown in emerging markets — and there are even warning signs in the United States, despite pretty good job growth at the moment."

Then he sets out to answer this question of why things areso bad. After all, we are many years past the housing bust and banking crisis, i.e., the causes of the Great Recession.

The sad truth is that the ongoing economic hardship around the word is and perhaps still is avoidable, in Krugman's view. It is the result of a series of policy mistakes: "Austerity when economies needed stimulus, paranoia about inflation when the real risk is deflation, and so on."

Next question, then, why do governments keep making these mistakes?

The answer, Krugman posits, is misplaced righteousness, overzealous moralizers intent on continuing to punish debtors even if doing so drags everyone down. Here is the background: Before the crash, credit was exploding. "Old notions of prudence, for both lenders and borrowers, were cast aside," Krugman writes. "Debt levels that would once have been considered deeply unsound became the norm.

Then the music stopped, the money stopped flowing, and everyone began trying to “deleverage,” to reduce the level of debt. For each individual, this was prudent. But my spending is your income and your spending is my income, so when everyone tries to pay down debt at the same time, you get a depressed economy.

So what can be done? Historically, the solution to high levels of debt has often involved writing off and forgiving much of that debt. Sometimes this happens explicitly: In the 1930s F.D.R. helped borrowers refinance with much cheaper mortgages, while in this crisis Iceland is outright canceling a significant part of the debt households ran up during the bubble years. More often, debt relief takes place implicitly, through “financial repression”: government policies hold interest rates down, while inflation erodes the real value of debt.

What’s striking about the past few years, however, is how little debt relief has actually taken place. Yes, there’s Iceland — but it’s tiny. Yes, Greek creditors took a significant “haircut” — but Greece is still a small player (and still hopelessly in debt). In major economies, very few debtors have received a break. And far from being inflated away, the burden of debt has been aggravated by falling inflation, which is running well below target in America and near zero in Europe.

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