News Article Analysis - Essay Example

In such a situation, contrary to economic rules, budget deficits and printing money do not drive up inflation and slashing government spending has a disastrous effect on incomes and employment. Low inflation discourages borrowing and spending and encourages sitting on cash. The persistent weakness in the economy forces businesses to cut prices and prevents workers from bargaining for better wages. Paul Krugman argues for the need to provide monetary and fiscal stimulus to the economy to reduce unemployment and increase economic activity.

He fears that letting these problems fester in the belief that these are short term problems would cause larger problems in the longer term. Conventional economic theory suggests that money supply is the most important factor in causing inflation, the classic explanation of “too much money chasing too few goods”. The $ 2 trillion that was injected into the economy should have caused the high inflation that many economists feared. However this perhaps was not real money injected into the system but more in the nature of a book adjustment for the distressed financial institutions.

The two other factors that could have driven inflation were however absent in the US economy, the demand-pull factor and the cost-push factor. The demand-pull factor has been weak because of high levels of unemployment and the pessimism about the future in large sections of the people. There was no cost-push factor perhaps due to the fact that the crisis was global in nature. The Euro zone has been in recession and the China growth rate has slowed, reducing demand for a whole range of commodities.

Conventional economic theory was formulated in a time period where each country’s economy was significantly insulated from others through geographic distance, tariff barriers and other obstacles to trade. These theories perhaps need re-examination in the light of the interconnection in global economy. Paul