Paul Krugman on Economic Hangovers

First of all, congratulations to Paul Krugman for winning this year's Nobel Prize in Economics, I don't think anyone expected him to win this year (with most people thinking that he would win after the end of a Bush presidency so that the prize would be entirely focused on his research work, not his political opinions) but I could not be happier.

Of course everyone is writing about him and why he is important now, but what better way to write about someone's career than to dive straight into his work. Here is an excellent article from Slate on why 'The Hangover Theory' that recessions are a necessary part of the economic cycle that follow booms and must be accepted as they are makes little sense when examined more closely. Here's an excerpt, but do read the whole thing.

The hangover theory is perversely seductive—not because it offers an easy way out, but because it doesn't. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love.

Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less.

Nor is this merely an academic argument: The hangover theory can do real harm. Liquidationist views played an important role in the spread of the Great Depression—with Austrian theorists such as Friedrich von Hayek and Joseph Schumpeter strenuously arguing, in the very depths of that depression, against any attempt to restore "sham" prosperity by expanding credit and the money supply. And these same views are doing their bit to inhibit recovery in the world's depressed economies at this very moment.