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Paul Krugman MIT Lecture

by Rafael Rosa on February 18, 2010

MIT has made a recent Paul Krugman lecture available to the public. The video and my notes/bullet points are below if you’re not feeling like watching the hour-long lecture.

Paul Krugman MIT Lecture Notes/Bullet Points

These are the things we thought we knew about the Great Depression:

- The Great Depression happened because we had an unprotected banking system and a monetary authority (Federal Reserve) that did not know the right thing to do.
- The Federal Reserve failed to provide liquidity and stop the sharp contraction in money supply.
- Government did not know what to do. It did not follow big enough Keynesian policies (i.e. fiscal expansion).
- In 1937, FDR and the Federal Reserve were convinced that the recession was over and decided to mop up excess liquidity and tighten fiscal policies, creating the “2nd Depression”.
- As a result of The Great Depression, we established banking insurance (FDIC) to rule out bank runs and created banking regulation to go along with the insurance policies.

What do we understand about the current crisis?

* It seems like we have a “tech-ed” up version of the events that happened in the 1930s.
* We’ve not had your typical ‘bank runs’, but we’ve had an economic equivalence (i.e. investors taking money out in bulk from short-term funds that were not in a position to do so in a very short notice).
* There was a “monstrous” housing bubble similar to the 1920s stock market bubble.
=> It’s interesting that we’ve had such a large bubble right after the technology bubble.
* The housing bust would have created recession no matter what.
* Keynes’ The Great Slump of 1930 could be applied to the current crisis by changing a few words around.

How is it possible that events similar to The Great Depression have been happening again?

* We’ve had a combination of mis-learning, forgetting some important lessons of the 1930s, and failing to generalize some key factors.
* There was a conviction that the Federal Reserve could always do what is necessary to avoid an economic slump.
* Milton Friedman believed that the Federal Reserve could have stopped the money supply contraction in the 1930s. However, we can see that the Federal Reserve’s ability to expand money supply is limited when banks keep hoarding excess reserves.
*People forgot how hard it is to move economic policy forward.
* Bank deregulation (due to the forgotten fact that banks can still go bad).
* Until the crisis, no one was concerned about the “shadow banking” system. However, we found out that it was also susceptible to ‘bank runs’.
* Nevertheless, the actual economic slump due to the current crisis has been better than the one during The Great Depression. The first year of the crisis was the same (e.g. slowdown in industrial production and world trade), but the after-effects in the system have been better handled.

Why has the post 2008 slump been less severe than the post 1930 slump?

* Financial institutions were saved
* We have bigger governments now than in the 1930s.
* Government has acted as a major economic stabilizer (e.g. social security payments, healthcare transfer payments, etc).
* Additionally, deliberate government actions such as the “stimulus” have helped prop up demand.
* Problem is not over. End of recession does not mean the economic slump is over.
* Most economists believe high unemployment will be present for a prolonged period of time.

What should we not do right now?

* We can’t pull out the economic support before a full recovery takes place (a lesson learned in 1937).
* However, it appears that we’re going to do just that.
=> The stimulus will reach its peak effect this summer. The Federal Reserve will also stop its mortgage securities buying program in the next few months.
=> There are also calls to cut the budget deficit.
=> All of this is happening while indications are that unemployment will stay high for a prolonged period of time.
* As a result, will there be a double dip recession? Who knows.
* Political policy is acting as the problem has been solved.
* We’re forgetting that the problem is not solved by preventing the initial economic free-fall. You need to support the economy for an extended period of time.

Why are we replaying the past?

* Part of the answer is politics.
* Politicians only want to do half of what economists are suggesting.
* Economists are also confused.

What happens now?

* I’m worried about where we are now.
* Consumers are heavy loaded with debt and firms have a lot of overcapacity.
* Worries about deficits may lead to cuts in fiscal spending which could create more problems.
* Our current actions are similar to the actions done in the mid 1930s.
* I don’t see anything that will change the current economic climate.
* In the long run, we’ll find a road to recovery. However, like Keynes said, in the long run, we’re all dead.

Q & A

What are the strengths and weaknesses of a fractional reserve system? Are there any alternatives?

* We can’t say what banks are allowed to do; however, we can decide what to insure (e.g. deposit insurance).
* Some people want banks to be just a big safe. However, the money will flow to somewhere else where the money will be put to work and earn a return.
* What we need to do is regulate things such as leverage, capital requirements, and reserve requirements.

What’s your opinion on the Euro?

* Greece has always been a problem. They’ve always mismanaged their finances.
* Spain is the real factor. They were responsible and even had a budget surplus a few years ago.
=> However, they’ve not had an adjusting mechanism do deal with their real estate bust.
* What’s happening to Spain is what people thought was not going to happen (A big Euro economy having problems because it has no adjustment mechanism).
* I don’t know what will happen to the Euro.
* Nevertheless, dropping out of the Euro is not really feasible. It’s also hard to see a breakup of the union.

Should we break up too big to fail companies?

* I don’t think big financial institutions are at the heart of the financial crisis.
* Bank runs can still happen even if we had many small banks. Think 1930.
* Canada has only 5 banks that dominate the system yet their doing just fine.
* My argument against these large institutions is that they have too much political influence and pretty much end up writing legislation.
* Overall, they’re not irrelevant, but it’s not the core macro problem.

Technorati Tags: credit crisis, Economic Policy, Financial Crisis, mit lecture, paul krugman

{ 1 comment… read it below or add one }

Citrus 02.24.10 at 10:36 pm

A nobel prize doesn’t quite fetch what it used to.
Thanks for the post Rafael.
Paul Blart- I_mean_Krugman, doesn’t ‘see a way out’ because he doesn’t understand the problem. If competition is good, why don’t we have competing currencies? Why are cartels bad for consumers, except when run by government-enforced bankers? What exactly are the problems that would be created by cuts in fiscal spending? Is overcapacity a horse with one horn?
Paulywog does not recognize that any government spending, in economic terms, is consumption! Even if the government manufactures tangible items, it is still consumption. Expropriating money from the private sector is never a net benefit.
It chills me to the bone to think that the general consensus of these macro geniuses is: we need sustained intervention to make our economy ‘work.’
It also find it unnerving the number of “I think”s and “probably”s in the utterances of such world-class geniuses. What ever happened to people who actually know something.
Whatever you do- do not treat economics like a science.

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