PAUL KRUGMAN


“If we don’t act swiftly and boldly,”President-elect Barack Obama declared early this month,“we could see a much deeper economic downturn that could lead to double-digit unemployment.”If you ask me, he was understating the case.

Recent economic numbers from around the world have been terrifying. Manufacturing is plunging everywhere. Banks aren’t lending; businesses and consumers aren’t spending. Let’s not mince words: This looks an awful lot like the start of a second Great Depression.

So will we“act swiftly and boldly”enough to stop that from happening? We’ll soon find out.

For many years most economists believed that preventing another Great Depression would be easy. In 2003, Robert Lucas of the University of Chicago told the American Economic Association that the“central problem of depression prevention has been solved, for all practical purposes, and has in fact been solved for many decades.”

Milton Friedman, in particular, persuaded many economists that the Federal Reserve could have stopped the Depression simply by providing banks with more liquidity, which would have prevented a sharp fall in the money supply.

It turns out, however, that preventing depressions isn’t that easy. Under Ben S.Bernanke’s leadership, the Federal Reserve has been supplying liquidity like firefighters trying to put out a raging blaze, and the money supply has been rising rapidly. Yet credit remains scarce, and the economy is still in free fall.

Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective in a depression and that fiscal policy - large-scale deficit spending by the government - is needed to fight mass unemployment. The failure of monetary policy in this crisis shows that Keynes had it right. And Keynesian thinking lies behind the Obama program.

But these plans may turn out to be a hard sell. The reality is that the political posturing has already started, with Republican leaders setting up roadblocks to stimulus legislation. After decades of declaring that government is the problem, not the solution, most Republicans aren’t going to accept the need for a big-spending solution to the economic crisis.

The biggest problem facing the Obama plan, however, is likely to be the demand of many politicians for proof that the benefits of the proposed public spending justify its costs - a burden of proof never imposed on proposals for tax cuts.

This is a problem with which Keynes was familiar: giving money away, he pointed out, tends to be met with fewer objections than plans for public investment“which, because they are not wholly wasteful, tend to be judged on strict ‘business’ principles.”

What gets lost in such discussions is the key argument for economic stimulus - that a surge in public spending would employ Americans who would otherwise be unemployed and money that would otherwise be sitting idle, and put both to work producing something useful.

Here’s my nightmare scenario: It takes Congress months to pass a stimulus plan, and the legislation that emerges is too cautious. As a result, the economy plunges for most of 2009, and when the plan finally kicks in, it’s only enough to slow the descent. Meanwhile, deflation sets in.

So this is our moment of truth. Will we in fact do what’s necessary to prevent Great Depression II?