'Depression Economics'

This may be the winter of Paul Krugman's content. President Bush, whose economic policies the celebrated New York Times columnist has derided from the beginning, is leaving office. Krugman has been awarded the Nobel Prize in Economics. And Norton has just published The Return of Depression Economics and the Crisis of 2008, a substantial revision of the book he originally published in 1999. Krugman spoke with NEWSWEEK senior editor Daniel Gross.

NEWSWEEK: First thing, I want to get out of the way is what to call you. Is it Professor Krugman, Your Nobelness, Dr. Krugman, or—as you're known in the blogosphere—The Shrill One?
Paul Krugman: I'll go for the last one, or just "Hey, you."

When most people think of depression economics, they tend to think of the TVA and the Hoover Dam—elements of the New Deal. But that's not what you're talking about here.
What I mean by depression economics is a situation in which Uncle Alan [Greenspan] can't save us. In every recession—and we've had lots of recessions—the head of the Federal Reserve cuts interest rates, the recession ends and things come back. Depression economics is a situation in which normal anti-recession medicine no longer works. That was true in the 1930s, it was true of Japan in the 1990s, it was true in a lot of developing countries and now it's true for us.

You first wrote this book in the 1990s, when you were looking at crises in Mexico and Asia. Americans, being very U.S.-centric, looked at those cases and saw them as mere blips in this long peacetime expansion. Obviously, that narrative didn't strike a chord with you then. What did we miss?
Japan. That was the case that rattled me even before we had the high-speed crises in other Asian countries. And that's because Japan, once you get past the funny food and the bowing, is a country that's a lot like us. It's an advanced, sophisticated country with a stable government, and they found themselves trapped. That made me think, well, if it can happen to them, why couldn't it happen to us? Maybe we don't have this depression thing under control like we thought we did.

One of the things that comes out of these case studies is the matter of unpredictable consequences. When the authorities respond as they're "supposed" to respond, there are still frequently consequences that the model tells you aren't going to happen.
It turns out this modern world financial system contains all kinds of nasty potential linkages that were not in the models. We somehow missed that until it happened on a large scale in Asia.

So by letting Lehman Brothers fail, there's now a crisis in the money markets.
This crisis started with people buying condos they couldn't afford in Miami, and now that's producing a horrific economic crisis in the Baltic states. It's all linked together. Letting Lehman fail—letting the market work, as some people said—basically brought the entire world capital market down.