It was interesting this morning to see George Will confidently put forth an economic theory — only to have his theory be immediately contradicted by a Nobel winning economist. Ouch.  Will probably still thinks he is right.

The discussion happened on the George Stephanoupolis program on ABC between Stephanoupolis and Cokie Roberts, Sam Donaldson, George Will, and Paul Krugman.

George Will’s theory of why the depression became the great depression is that government intervention prevented the markets from working. Krugman disagreed and said it was the collapse of the financial system that was at fault, and it was an increase in taxes, along with a policy of balancing the budget that Roosevelt imposed in 1937. Wow. I need to go back and study my history.

Krugman said that only an enormous government public project — World War 2 — eventually turned the economy around.

About the question of bailing out the auto companies, Krugman said that if the question had been asked in 1999, when the economy was strong, his advice would have been to allow the auto companies to go bankrupt — chapter 11. The companies would have continued to operate on borrowed capital and under the bankruptcy rules, they would be required to undergo major restructuring.

Krugman says that because of the bad state of the overall economy he reluctantly favors a government bailout of the auto industry. He gives two reasons:

  1. The credit lines normally available to the auto companies are now frozen, so a Chapter 11, bankruptcy, would quickly turn into a chapter 7, liquidation. Such a liquidation would mean that over one million jobs would evaporate.
  2. And so, the net result to the economy would be a negative stimulus, and in the terrible slump we are in, a negative stimulus is the last thing we should be engineering.
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