Paul Krugman is thinking like I am thinking about the radicalism of the Grandees of Europe, and especially of the ECB:
Wild-Eyed Theorists In Pinstripes: [W]e have a couple of centuries’ experience with central banking, and that experience clearly shows that the lender of last resort function is crucial. The Federal Reserve basically was created after America had to rely on J.P. Morgan to fill that role in the panic of 1907, and it was recognized that one couldn’t always count on having a J.P. Morgan on hand when you needed one…. Yet we have some people in Frankfurt who are apparently dedicated to the proposition that they can be Europe’s central bank without performing that function… a radical theory at odds with evidence and experience. And it’s a theory that could kill the euro….
The crisis we’re in is not something unprecedented. It’s a close cousin to the Great Depression — milder, but recognizably the same sort of thing. And we understand — or used to understand — how the Depression happened, and what to do…. So how is it that policy is so confused and lost? I’ve been arguing for a while that much of the economics profession has lost its way…. But it’s not just economists…. On Monday night… Chris Sims… pointed out that central banks have always had a wider mandate than simply guaranteeing price stability…. And there are good, well-understood reasons for this wider mandate. Yet the creators of the euro essentially threw away hard-won wisdom…. The result of all this is that the supposedly sober, serious people are actually radicals insisting that we can make the economy work in ways that it has never worked in the past — hence the embrace of magical thinking on expansionary austerity and the power of structural reform. Meanwhile, the irresponsible bearded professors are actually the custodians of traditional wisdom…
Rational Irrationality: I was on Leonard Lopate’s WNYC radio show… Leonard asked me an interesting question: Has the financial crisis and Great Recession produced any big new economic ideas? My immediate response was that it hasn’t…. But I do think that some important ideas have been discovered—or, rather, rediscovered. Here are six….
Finance matters…. [M]any economists somehow managed to forget it. Two who didn’t were Hyman Minsky and Wynne Godley….
Credit busts are different from ordinary recessions…. Carmen Reinhart and Ken Rogoff’s historical survey, “This Time is Different: Eight Centuries of Financial Folly”…. Irving Fisher’s famous essay from 1933….
Positive feedback and multiple equilibria have to be taken seriously….
Especially in financial markets, self-regarding rational behavior isn’t necessarily socially optimal….
Monetary policy doesn’t always work very well. This lesson should have been relearned in Japan. One person who did relearn it was Paul Krugman. This essay of his from 1998 explains how economies can get stuck in a “liquidity trap,” and is still worth reading, as his book “The Return of Depression Economics,” an updated version of which was reissued in 2008.
Fiscal stimulus programs don’t provide a panacea for deep recessions, but the alternatives—do-nothing policies or austerity—are much worse. If you doubt this, I would suggest you look at what is happening in Greece and the United Kingdom…
Mark Thoma comments:
Economist's View: Important Ideas Have Been Discovered—or, Rather, Rediscovered: I'll add one more: Before the crisis Alan Greenspan assured us that there wasn't a housing bubble, and even if there was, and it popped, the Fed could contain its effects and clean up afterward. Nothing to worry about. That was wrong…. The Fed needs better ways to identify bubbles. Because of the belief that bubbles could be contained and easily mopped up, little effort was made to find ways to identify bubbles as they were inflating. Now that we know how much damage bubbles can do -- something we should have known already -- we need to put effort into finding reliable indications of bubbles, and then take action to stop them from doing severe damage.
Another: In this type of recession, saving banks is not enough to restore the economy. It's critical to help households too.