History matters

Paul Krugman makes a great point in his blog today about the importance in macroeconomics of understanding economic history.  And he does not just mean the business cycle in the US over the last 40-50 years.  Instead there is much to be learned, he argues, from the experiences of Germany after World War I and the issues faced in developing countries such as Mexico, Indonesia and Argentina.  The current financial and economic crisis has some unique factors, especially the role of derivatives and the shadow banking system, but it was largely created by an age-old factor -- too much debt that was too highly leveraged. 

Krugman and I are rarely on the same page concerning what should be done in the current crisis (he thinks the jobs bill proposal is too modest), but his warning should be taken to heart:

Unfortunately, many economists have not learned from the past. And that’s at least part of the reason we are apparently condemned to repeat it.

Greece is the word

Paul Krugman's NYT column today does a great job explaining the sources of the Greek economic crises and pointing out the limited options available to deal with it.  The essence of the problem is that even though Greece's economic issues may not be as severe as those facing some some states in the US, states such as California can rely on federal programs such as Social Security, grants and stimulus packages whereas there is no European central government with taxing and spending authority to help Greece out. Krugman believes that Greece will ultimately have to go off the Euro and issue a new devalued currency that will reduce real wages and make Greek exports economically competitive.  A debt default a la Argentina in 2001 is also in the cards.  Other European governments (Portugal, Spain, Ireland in particular) could be in the same boat.  Krugman seems to think this will not be as disruptive as the fall of Lehman Brothers; I hope he is right.

Krugman on financial regulation

Worthwhile NYT column from Paul Krugman today on financial regulation. Krugman's main point is that regulators should worry more about the activities of banks (e.g., leverage) than their size. He points out that literally thousands of small banks were wiped out in the Great Depression because they had inadequate reserves and there was no deposit insurance to stop bank runs. Krugman also notes that Canada's big banks did ok in 2008, perhaps because they were more tightly regulated.

I still worry about the political economy of large financial institutions, in particular their ability to use campaign contributions and lobbyists to obtain regulatory outcomes to their own liking. Maybe Krugman will deal with this issue in a later column.

We really do have reason to be thankful

Great column in yesterday's WSJ by James Stewart about why we should be thankful for Henry Paulson, Tim Geithner, and Ben Bernanke. Stewart's message in a nutshell: Many of us seem to have forgotten how close the economy came to a total meltdown last fall. The Paul Krugmans and Glenn Becks of the world are making emotionally charged arguments (and collecting huge salaries and speakers fees, I might add) second guessing the bailouts and stimulus packages respectively. But guess what? The Bush and Obama economic teams made the right calls on the biggest issues. Without the bailouts 2009 would have been an economic rehash of 1930. Without the monetary and fiscal stimulus (from both Bush and Obama) unemployment would easily be 12 or 13 percent. Stimulus packages in other countries also have been effective; the global economy is starting to recover. Money quote:

We're a lot better off today than we were a year ago. This week I'll be giving thanks for that.

"Superfreakonomics" on global warming

The sequel to the best-selling "Freakonomics" by Chicago economist Steve Levitt and journalist Stephen Dubner is about to hit the shelves. Their last chapter deals with global warming, and apparently a major storm has broken out in the blogosphere over their conclusion that more attention needs to be paid to geo-engineering as a solution. Levitt and Dubner's blog on the NYT website summarizes their conclusions. For a critique, check out Paul Krugman's blog on the same website.

Response to Krugman's NYT piece

John Cochrane, an economist at the University of Chicago, responds to Paul Krugman's article with this piece: "How Did Paul Krugman Get It So Wrong?". The link is courtesy of Greg Mankiw. I do not normally borrow from blogs with much higher readership, but in this case I wanted to make sure alternate views were aired.

Krugman on macroeconomics

Excellent and fairly balanced article by Nobel laureate Paul Krugman: "How Did Economists Get It So Wrong?" coming out in NYT Sunday magazine. Well worth reading. I must admit that I always found the extreme versions of "freshwater" macroeconomics a bit hard to swallow. However, I am not buying Krugman's call to put Keynes at the centerpiece of modern macro thinking. Even if every economist on the face of the earth used Keynesian modelling, would it have made any difference over the last year? Who besides Nouriel Roubini (aka Dr. Doom) forecasted the severe recession accurately? And before you give Roubini too much credit, please realize some economist somewhere is always saying "the end is near!"

Finance students: be sure to read about Larry Summers theory of ketchup economics!

Will Goldman Sachs be the next Freddie Mac?

Paul Krugman seems to think so in his column in today's NYT. Wait, Krugman must be nuts, didn't Goldman Sachs just report billions of dollars in second quarter profits? But here's the rub: Goldman was one of many financial services companies that was deemed too big to fail last fall. No changes in financial regulation are on the horizon; Congress is focusing on cap-and-trade and health insurance instead and the President seems happy with that. Compensation practices have not changed, as Krugman notes

The huge bonuses Goldman will soon hand out show that financial-industry highfliers are still operating under a system of heads they win, tails other people lose. If you’re a banker, and you generate big short-term profits, you get lavishly rewarded — and you don’t have to give the money back if and when those profits turn out to have been a mirage. You have every reason, then, to steer investors into taking risks they don’t understand.

So what will happen? Bankers will take even bigger risks, one day they will find they have placed their bets on the wrong side, and guess who is left holding the bag? Krugman's take: the government needs to insist on tighter regulations as long as the Goldman Sachs and its ilk are in effect wards of the state. An alternative view I would like to see someone flesh out -- if these institutions are too big to fail, maybe we should bust them up so they aren't too big?