Cause and Effect in European Politics and Law

Is the recovery really a recovery?

Adelina Marini, June 16, 2009

And while the financial ministers of G8 are cautious in their optimism after their meeting in Lecce, Italy, in the US the calls for return to traditional business are becoming louder and louder. That is why the famous economist and "International Herald Tribune" columnist Paul Krugman writes that a few months ago the American economy was in danger of falling into depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. And suddenly critics are demanding that we call the whole thing off, and revert to business as usual. Those demands should be ignored, advises Krugman. "It’s much too soon to give up on policies that have, at most, pulled us a few inches back from the edge of the abyss". He also gives the following examples:

Now is the third time in history that a major economy has found itself in a liquidity trap, a situation in which interest-rate cuts, the conventional way to perk up the economy, have reached their limit. When this happens, unconventional measures are the only way to fight recession. "The first example of policy in a liquidity trap comes from the 1930s. The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment. Yet policy makers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy, while F.D.R. tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II", Krugman writes in his article.

The second example is with Japan in the 1990s. "After slumping early in the decade, Japan experienced a partial recovery, with the economy growing almost 3 percent in 1996. Policy makers responded by shifting their focus to the budget deficit, raising taxes and cutting spending. Japan proceeded to slide back into recession".

Now there is a danger that we repeat the same mistake, warns the US economist, because some people, mainly in Europe, argue that stimulus isn’t needed, because the economy is already turning around. Others claim that government borrowing is driving up interest rates, and that this will derail recovery. The essence of the problem, according to Krugman, is in the expectations of the experts for quick results after a measure is introduced and that cannot happen like it never happened so far.