The deeply, deeply deflationary side of the Eurozone crisis (graph)
from Merijn Knibbe
Today, Krugman published a briljant blogpost about the Great and the Lesser Depression. Still, he makes a crucial mistake. When explaining how a financial crisis like the Great Depression could be followed by a fast recovery in 1933-1937 he states (his mistake is highlighted):
But what about 1929-33? This clearly was a financial-crisis slump, and was followed by four years of fast growth. Reinhart-Rogoff are right to say that the key point should still be that unemployment remained far about pre-crisis levels. Still, why was growth fast in the aftermath of this crisis?
Well, I have a hypothesis — not necessarily excluding other stories. Here it is: growth was fast after 1933 because policy was so bad, specifically because the banking system was allowed to implode. This set the stage for fast catch-up growth as a functioning financial system was reconstructed, although the lingering overhang of private-sector debt prevented a full recovery. But that’s the contrast with 2007-2009, where the banks were rescued, avoiding complete collapse but also and therefore obviating the possibility of a fast bounceback.
What evidence can I present? One piece of evidence would be the old Friedman-Schwartz data on money supply, which was allowed to collapse in 1929-33 but not this time around.
Well, that’s wrong. Money supply did collapse, this time around. Not everywhere – but it did in Spain, Italy, the Baltic states and especially in Ireland and Greece. And politicians did not only allow this – they did about everything in their power to aggravate this. The graph shows money ‘growth’ in Greece. I’ve added lines with the level of money growth consistent with the ECB Eurozone ‘target ‘of 4,5%, with the implicit Greece ‘target’ assuming that trend economic growth in Greece is about 1% higher than for the entire Eurozone and the level consistent with Greek recovery growth of 6 to 8% a year. Remember: “loans create deposits”, in a recovery this money is created by loans to invest in new activities.
Krugman is clearly 50% off the mark when we look at the total decrease of the amount of Greek money and compare this with the level consistent with ‘normal’growth.
Source: Greek central bank
1. The amount of M-3 money can basically change because bank debts are paid, because it leaves the country or because it is changed into other assets (deposit money which is for instance transferred to a five year savings account)
2. The idea that a central bank can control the stock of money is of course hubris. But this does not rule out a more or less stable relation between money and economic activity, in the absent of asset bubbles.