Economics in the Crisis Paul Krugman Shar Clark

Who is Paul Krugman? B.A. from Yale in 1974 Ph.D. from MIT in 1977 Has taught at Yale, MIT, and Stanford Author and editor of 20 books and over 200 papers in professional journals and edited volumes Nobel Memorial Prize in Economics (2008) International Economics- New Trade Theory

Trade Theory Trade theory before Krugman: emphasized trade based on the comparative advantage of countries with very different characteristics (agricultural country trading with an industrial country) In 20 th century similar countries traded, not explained by comparative advantage.

New Trade Theory Two key assumptions: that consumers prefer a diverse choice of brands, and that production favors economies of scale. Consumers prefer diversity in their options, so countries specialize and trade with one another Because of economies of scale countries can specialize and stay in business

Economics in Crisis First, general role of economics in times of crisis Then role economics should have been playing in the past few years and the reasons why it has for the most part not been doing this role Then what they could do in the future

Paradox of Economics Times of economic disturbance and disorder are times when economic analysis is especially likely to be wrong. Yet such times are also when economics is most useful

What role should economics have? In calm times: Very little: can explain why systems work the way they do, but can’t make predictions that are accurate (stocks and exchange rates) People that have real world experience are more equipped for those things

What role should economics have? In disturbed times: Dramatically better predictions and policy judgments than those with more real world experience Economists have models that allow them to make useful analysis and predictions

“ Crises are times when economics and economists can and should really prove their worth… all too many of us rejected the very kinds of analysis that were to prove so useful. And more than that, all too many actively opposed the policy measures the crisis called for.”

What should economists have known? NOT that they didn’t predict this “infact it’s not reasonable to criticize economists for failing to get the year of the crisis right, or any of the specifics of how it played out, all of which probably depended on detailed contingencies and just plain accident.”

What should economists have known? CAN BE CRITICIZED FOR: not seeing that this was a likely event Shouldn’t have been hard to realize that when an institution is using overnight borrowing for longer-term investment was inherently vulnerable. Also that these institutions that were doing this weren’t regulated

What should economists have known? Fallacy of misplaced concreteness: just because institution does not look like regular banks does not mean they were not still engaged in bank-like risks and activities “So, economists fell down on the job by not seeing what were in retrospect clear warning signs that the kind of crisis that struck in 2008 was both possible and becoming increasingly likely.”

What should economists have known? How to respond to the crisis If the depression hit 40 years ago economists would have had a uniform way of responding to the crisis because everyone knew of IS-LM analysis- but by 2008 most of Krugman’s colleagues had forgot about it or rejected that type of analysis.

The failure of economics “The best you can say about economic policy in this slump is that we have for the most part avoided a full repeat of the great depression” ‘in part’- depression level slump in Greece and very bad slumps in parts of Europe

“In normal times, when things are going pretty well, the world can function reasonably well without professional economic advice. It’s in times of crisis, when practical experience suddenly proves useless and events are beyond anyone’s normal experience, that we need professors with their models to light the path forward. And when the moment came, we failed.”