Paul Krugman has an unsettling column today limning the fear that the stimulus plan will be insufficient to the challenges facing the economy. He sets up the theoretical argument on how to respond to a potential depression by sketching John Maynard Keynes’ views on the matter, and Milton Friedman’s response. Keynes feared what he called a “liquidity preference.” In times of economic anxiety, businesses and consumers won’t want to spend, even if they have the liquid cash. When fearful, people hoard. It’s a psychological response. Give them more money, and they’ll hoard that too. This reduces total spending, and brings demand beneath what’s needed for a healthy economy. This was, essentially, a behavioral economics take on depressions. The only actor able to disrupt the cycle is the government, as it can spend on the deficit, and has different incentives than a family or an individual business.
Friedman had a different answer. He argued that the Depression was a failure of monetary policy. The Federal Reserve should have acted quickly to increase the money supply and get quick cash into the hands of banks, who could then lend it at low rates, which would attract consumers and businesses who wanted to spend. Rather than assuming low spending the product of a preference for cash, he assumed it the product of not having enough cash. But Krugman argues today that though the Fed has been supplying liquidity as fast as possibly, and though they’ve effectively increased the money supply by quite a bit, the problem persists.
To Krugman, in other words, Friedman has failed. Now we need to try Keynes. And we need to try him with policies in proportion to the scale of the problem. In the column, Krugman isn’t precisely clear on what that means. But presumably, that’s why he’s got a blog.
