Paul Krugman thinks we’re headed for a third depression — in fact, it may already have begun:

Recessions are common; depressions are rare. As far as I can tell, there were only two eras in economic history that were widely described as “depressions” at the time: the years of deflation and instability that followed the Panic of 1873 and the years of mass unemployment that followed the financial crisis of 1929-31.
[…]
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost — to the world economy and, above all, to the millions of lives blighted by the absence of jobs — will nonetheless be immense.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.
[…]
Why the wrong turn in policy? The hard-liners often invoke the troubles facing Greece and other nations around the edges of Europe to justify their actions. And it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine.

It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.

Just how self-defeating is laid out in detail on the New York Times editorial page:

Without doubt, the two biggest threats to the economy are unemployment and the dire financial condition of the states, yet lawmakers have failed to deal intelligently with either one.

Federal unemployment benefits began to expire nearly a month ago. Since then, 1.2 million jobless workers have been cut off. The House passed a six-month extension as part of a broader spending bill in May, but the Senate, despite three attempts, has not been able to pass a similar bill. The majority leader, Harry Reid, said he was ready to give up after the third try last week when all of the Senate’s Republicans and a lone Democrat, Ben Nelson of Nebraska, blocked the bill.

Meanwhile, the states face a collective budget hole of some $112 billion, but neither the House nor the Senate has a plan to help. The House stripped a provision for $24 billion in state fiscal aid from its earlier spending bill. The Senate included state aid in its ill-fated bill to extend unemployment benefits; when that bill failed, the promise of aid vanished as well.

As a result, 30 states that had counted on the money to help balance their budgets will be forced to raise taxes even higher and to cut spending even deeper in the budget year that begins on July 1. That will only worsen unemployment, both among government workers and the states’ private contractors. Worsening unemployment means slower growth, or worse, renewed recession.
[…]
The situation cries out for policies to support economic growth — specifically jobless benefits and fiscal aid to states. But instead of delivering, Congressional Republicans and many Democrats have been asserting that the nation must act instead to cut the deficit. The debate has little to do with economic reality and everything to do with political posturing. …

Deficits matter, but not more than economic recovery, and not more urgently than the economic survival of millions of Americans. A sane approach would couple near-term federal spending with a credible plan for deficit reduction — a mix of tax increases and spending cuts — as the economic recovery takes hold.

But today’s deficit hawks — many of whom eagerly participated in digging the deficit ever deeper during the George W. Bush years — are not interested in the sane approach. In the Senate, even as they blocked the extension of unemployment benefits, they succeeded in preserving a tax loophole that benefits wealthy money managers at private equity firms and other investment partnerships. They also derailed an effort to end widespread tax avoidance by owners of small businesses organized as S-corporations. If they are really so worried about the deficit, why balk at these evidently sensible ways to close tax loopholes and end tax avoidance?

And if massive cuts to public spending are the magic pill that will produce deficit reduction, economic growth, and increased investor confidence, then why — as Krugman indicated above and as Liz Alderman documents in the Global Business section of the New York Times a couple of days ago — is precisely the opposite happening in countries like Ireland, Greece, Portugal, Italy, and Spain? (Emphasis is mine.)

As Europe’s major economies focus on belt-tightening, they are following the path of Ireland. But the once thriving nation is struggling, with no sign of a rapid turnaround in sight.

Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes, the type of austerity measures that financial markets are now pressing on most advanced industrial nations.

“When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow,” said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. “A lot of the argument was, ‘Let’s get this over with quickly.’ ”

Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.

Joblessness in this country of 4.5 million is above 13 percent, and the ranks of the long-term unemployed — those out of work for a year or more — have more than doubled, to 5.3 percent.

Now, the Irish are being warned of more pain to come.
[…]
Despite its strenuous efforts, Ireland has been thrust into the same ignominious category as Portugal, Italy, Greece and Spain. It now pays a hefty three percentage points more than Germany on its benchmark bonds, in part because investors fear that the austerity program, by retarding growth and so far failing to reduce borrowing, will make it harder for Dublin to pay its bills rather than easier.

Other European nations, including Britain and Germany, are following Ireland’s lead, arguing that the only way to restore growth is to convince investors and their own people that government borrowing will shrink.

The Group of 20 leaders set that in writing this weekend, vowing to make deficit reduction the top priority despite warnings from President Obama that too much austerity could choke a global recovery and warnings from a few economists about the possibility of a much sharper 1930s style downturn.

“Europe is in a tough bind,” said Kenneth S. Rogoff, a former chief economist at the International Monetary Fund and now a Harvard professor. “If you want to escape default, the Irish path is the only way to go. But the Ireland experience points to the profound challenges that the current strategy implies.”

Don’t you love that euphemistic language? Rogoff’s not the one facing those “profound challenges,” is he?

Politicians [in Ireland] have raised taxes and cut salaries for nurses, professors and other public workers by up to 20 percent. About 30 billion euros ($37 billion) is being poured into zombie banks like Anglo Irish, which was nationalized after lavishing loans on developers.

The budget went from surpluses in 2006 and 2007 to a staggering deficit of 14.3 percent of gross domestic product last year — worse than Greece. It continues to deteriorate. Drained of cash after an American-style housing boom went bust, Ireland has had to borrow billions; its once ultralow debt could rise to 77 percent of G.D.P. this year.
[…]
Wage cuts were easier to impose here because people remembered that leaders moved too slowly to overcome Ireland’s last recession. This time, Mr. Cowen struck accords swiftly with labor unions, which agreed that protests like those in Greece would only delay a recovery.

But instead, cutting wages and benefits is what’s helped to delay the recovery:

But pay cuts have spooked consumers into saving, weighing on the prospects for job creation and economic recovery. And after a decade-long boom that encouraged many from the previous years of diaspora to return, the country is facing a new threat: business leaders say thousands of skilled young Irish are now moving out, raising fears of a brain drain.

I really am concerned that fiscal conservatives don’t understand basic economic principles. You simply don’t cut spending in a severe economic downturn. When there is widespread joblessness, when unemployment is high and tens of millions of people (in the United States) don’t have health insurance, and foreclosures and evictions are going through the roof, and food stamp and Medicaid applications are skyrocketing, and state governments are having to lay off teachers and close schools and slash budgets for garbage pickup and police and fire protection, that is not the time for the federal government to impose spending cuts. When businesses don’t have the money to hire or retain workers, and when those unemployed workers are losing their homes and having their cars repossessed, and when vast swathes of the country’s population do not even have the money to pay basic expenses much less have money to spend on consumer goods or vacations or homes, that means that somehow money has to get into the economy again. The only entity that has money in the amounts needed to prevent economic collapse is the government. Businesses don’t have it. Ordinary people don’t have it. So if the government decides it’s going to spend its money on paying down debt, or on cutting corporate taxes or handing out tax cuts targeted to the wealthiest Americans, and isn’t going to spend its money on the economy, how is the money going to get into the economy?

If this seems too complicated, I’ll make it real simple. If Congress cuts the corporate tax rate and, say, Barnes and Noble, Inc., gets a nice big fat tax cut on its corporate taxes, but no one is buying books because Congress cut off their unemployment checks and they lost their homes and can’t pay their bills, is Barnes and Noble going to hire more booksellers because now they got this nice big tax cut? Companies don’t hire if they don’t think there are enough customers out there to buy the products they make or the services they offer. Now, if someone wants to say it’s a good thing to put millions of dollars in the pockets of corporate CEOs that isn’t going to get spent on jobs,  then say it loud and strong — after all, this is America, right? Myself, I think it makes more sense to put money directly into the pockets of the ordinary Americans who will spend it in the economy, but hey I’m just a Democrat who doesn’t really understand how the economy works.

Kathy Kattenburg

PAST CONTRIBUTOR.