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Friday, February 08, 2008

Krugman on the Economy

by Calculated Risk on 2/08/2008 09:03:00 PM

From Professor Krugman at the NY Times: A Long Story

The economic news has been fairly dire this week. The credit crunch is getting worse, and a widely watched indicator of trends in the service sector — which is most of the economy — has fallen off a cliff. It’s still not a certainty that we’re headed into recession, but the odds are growing greater.

And if past experience is any guide, the troubles will persist for a long time — say, into the middle of 2010.

The problems now facing the U.S. economy look a lot like the problems that caused the last two recessions — but this time in combination.

On one side, the bursting of the housing bubble is playing the role that the bursting of the dot-com bubble played in 2001. On the other, the subprime crisis is creating a credit crunch reminiscent of the crunch after the savings-and-loan crisis of the late 1980s, which led to recession in 1990.
My view was the S&L crisis didn't cause the '90/'91 recession, but I do think it left the economy susceptible to a downturn. Krugman argues the S&L credit crunch led to the '90/'91 recession.

There was a housing bubble in the late '80s that also contributed to the '90/'91 recession, combined with a decrease in defense spending (that hit California especially hard). Recessions usually have multiple causes.
Since the current problems of the U.S. economy look like a combination of 1990 and 2001, the shape of this episode of economic distress will probably be similar to that of the earlier episodes: even if the official recession is short, the bad times will linger well into the next administration.

How severe will the distress be? The double-bubble nature of the underlying problem — a housing bubble and a credit bubble combined — suggests that it may well be worse than either 1990 or 2001.

And some highly respected economists are issuing dire warnings. There has been a lot of buzz about a new paper by Carmen Reinhart and Kenneth Rogoff that compares the United States in recent years to other advanced countries that have experienced financial crises. They find that the U.S. profile resembles that of the “big five crises,” a list that includes, for example, Sweden’s 1991 crisis, which caused the unemployment rate to soar from 2 percent to 9 percent over a two-year period.
If the unemployment rate increases 7 percentage points, then we will definitely have a severe recession.