John Case on Krugman's Depression Economics

"Depression Economics" and Recovery

“Depression economics” is a term that Krugman came up with over a decade ago. His main point is that monetary policy, once you get into a depression, becomes ineffective, and the only possible way to manage the economy or influence its direction once interest rates have reached zero – which, coincidentally, they are pretty close to right now – is by means of very aggressive financial intervention by the federal government, not just in terms of liquidity, but by employing people directly or indirectly so they have the power to purchase things. This is the only way, according to depression economics, that you can effect a recovery in the economy.

Depression economics overthrows the reigning ideology, which, under the influence primarily of Milton Friedman, has long asserted that it was the failure of an injection of sufficient liquidity by the Fed that caused the Great Depression. Friedmanism maintains that by simply manipulating interest rates you can adequately influence the expansion or contraction of the economy, so that you do not need to think about any federal programs or entitlements, or anything else. This is a conservative view that fits in very nicely with the interests of people who wanted no government. For many years it has been the dominant philosophy, because for years a combination of reasonably steady growth and moderate inflation has allowed interest rates to have enough flexibility. That is, they remained high enough so that if you needed to bring them down a bit you could have an effect. This situation led a wide range of people, from the center to the extreme right wing, to transform Friedmanism into a kind of free market fundamentalism, which probably even Friedman never would have completely endorsed.