Some Fed officials and various commentators, such as Professor Paul Krugman, are of the view that the US central bank should be ready to consider additional steps to boost the US economy in the wake of a visible softening in key economic data. For instance, the yearly rate of growth of retail sales, after climbing to 8.5% in March, have fallen to 4.8% in June. The ISM manufacturing purchasing manager’s index (PMI) fell to 56.2 last month from 59.7 in May.

The housing market also shows visible weakening. The growth momentum of new home sales has plunged in May. The yearly rate of growth of sales fell to -18.3% in May from 30.8% in April. The growth momentum of housing starts also displays a visible decline. Year-on-year the rate of growth fell to 7.8% in May from 38.2% in the month before. Furthermore, in the week ending July 9, demand for loans to purchase homes, as depicted by the mortgage purchase index, fell 3.1% to 163.3, the lowest level since December 1996.

In his articles in the New York Times on the June 27 and July 11, professor Paul Krugman warns that without a dramatic fiscal and monetary stimulus the US economy is running the risk of falling into a prolonged depression.

According to Krugman things were different in 2008–2009:

In 2008 and 2009, it seemed as if we might have learned from history. Unlike their predecessors, who raised interest rates in the face of financial crisis, the current leaders of the Federal Reserve and the European Central Bank slashed rates and moved to support credit markets. Unlike governments of the past, which tried to balance budgets in the face of a plunging economy, today’s governments allowed deficits to rise. And better policies helped the world avoid complete collapse: the recession brought on by the financial crisis arguably ended last summer.[1]

Despite the stimulus, which Krugman labels as good policy, this wasn’t sufficient to erase the still-enormous unemployment levels. Hence Krugman’s view that more stimulus is required. Unfortunately, argues our New York Times columnist, policy makers are currently moving away from sound policies.

Around the world … Governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.[2]

Krugman maintains that the current move towards more conservative policies, which he labels as hard-money and balanced-budget orthodoxy, has little to do with rational analysis. According to our professor, this type of thinking will lead to another economic depression and massive unemployment,

And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.[3]

In the face of a weakening in the rate of growth of various price indexes, Krugman holds that the Fed should act swiftly to prevent the economy falling into a deflationary black hole.

Mr. Bernanke’s “it” isn’t a hypothetical possibility, it’s on the verge of happening. And the Fed should be doing all it can to stop it. Read More

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