Recipe for a Double Dip Recession

Both Krugman and Stiglitz rage at moronic austerity programs using examples that don't apply to justify contracting spending before the economy has fully recovered.

Fiscal stimulus is out of fashion now. World leaders embarked on that strategy – injecting money to re-energise the economy – after the banking crash three years ago. It was widely perceived not to have worked because the money governments pumped into the banks was not passed on to ailing businesses or individuals in trouble with their mortgages.

"The problem was that, in the US, the stimulus wasn't big enough," he says. "Too much of it was in tax cuts. And when they gave money to the banks they gave it to the wrong banks and, as a result, credit has not been restored – we can expect a couple of million or more homes to be repossessed this year than last year – and the economy has not been restarted." Instead of producing a consensus that the government should have done more, it has created disillusion that the government can do anything, Stiglitz says.

The result is that, following the attacks by the financial markets on Greece and then Spain, everybody is now in a mood of retrenchment. "It's not just pre-Keynesian, it's Hooverite," he says. By which he means governments are not just refusing to stimulate, they are making cuts, as Herbert Hoover did in the US in 1929 – when he turned the Wall Street Crash into the Great Depression. "Hoover had this idea that, whenever you go into recession, deficits grow, so he decided to go for cuts – which is what the foolish financial markets that got us into this trouble in the first place now want."

It has become the new received wisdom throughout Europe. But it is the classic error made by those who confuse a household's economics with those of a national economy.

"If you have a household that can't pay its debts, you tell it to cut back on spending to free up the cash to pay the debts. But in a national economy, if you cut back on your spending, then economic activity goes down, nobody invests, the amount of tax you take goes down, the amount you pay out in unemployment benefits goes up – and you don't have enough money to pay your debts.

"The old story is still true: you cut expenditures and the economy goes down. We have lots of experiments which show this, thanks to Herbert Hoover and the IMF," he adds. The IMF imposed that mistaken policy in Korea, Thailand, Indonesia, Argentina and hosts of other developing countries in the 1980s and 1990s. "So we know what will happen: economies will get weaker, investment will get stymied and it's a downward vicious spiral. How far down we don't know – it could be a Japanese malaise. Japan did an experiment just like this in 1997; just as it was recovering, it raised VAT and went into another recession."

Krugman blames the flight from the uncomfortable and counter-intuitive conclusions of macro-economics. The mean-spirited and small minded are still convinced there is some kind of demonstration of good values in attacking the poor and giving the rich tax cuts.

Like social conservatives who oppose sex education and birth control despite how effective they are at reducing STDs and unplanned pregnancies because they're afraid condoning them means condoning immoral sexual behavior, economic conservatives oppose social spending no matter how effective its been repeatedly shown at shortening recessionary economies because they believe condoning it would mean condoning immoral economic behavior.

We are risking plunging the whole economy back into recession, even depression rather than having our political leaders risk being seen to be soft on welfare mothers.

UPDATE: Krugman: We may be entering a long depression.