by Mario Rizzo
Some time ago I wrote a post with this name.
Now Paul Krugman is at it again with his ex-cathedra pronouncements. He says that because of the recent planned move by European countries in the direction of austerity and the talk in the US about austerity, we are on the verge on a “third” great depression in American history.
It is hard to know how to respond. Krugman has no evidence. He just repeats the Keynesian dogmas about spending and worries about deflation (of a persistent nature, he had better mean).
There is a certain madness in all of this.
What does the record show?
We have had fairly rapid economic growth recently (let us abstract from the reason for the moment), unemployment is falling, albeit slowly, the fiscal deficit is enormous, interest rates are at incredible lows, the monetary base has expanded beyond anything we have known, and the bond markets are reacting to years of unsustainable government spending in European countries.
Furthermore, we face government created uncertainties in the healthcare markets, the coming bankruptcy of Medicare and Medicaid, difficulties with Social Security as the population ages, state and local governments which have refused to make sensible reforms in the provision of their “vital” services for decades, and so forth.
And the root of our problems, says Krugman, is the lack of Aggregate Demand. If only we would demand more, then the world economy would snap back into full-employment equilibrium.
Does Krugman ever acknowledge the real controversy over whether the first (Bush) and second (Obama) stimulus packages had any substantial effect?
Does he acknowledge that there are very smart people out there who disagree with him?
Does he respond to his critics with respect, with seriousness, with data, with a recognition that economic theory has not stood still since Keynes wrote?
I think the answers are obvious.
ThinkMarkets 
Plus we have the expiration the Bush tax cuts, which will bring a rise in marginal rates. In 2011, we will see resets of ARMs taken out in 2006. Many borrowers will not be able to refinance, or only at less advantageous rates.
The fundamental problem with the stimulus story is that, in Laurence Kotlikoff’s words, it assumes the public is stupid. The government spends now and raises taxes later. Consumers are supposed to be “stimulated” by today’s spending, and clueless about tomorrow’s taxes.
One does not need to subscribe to Ricardian equivalence (Ricardo himself didn’t) to conclude that taxpayers do understand there is no free lunch. Never has the public been more focused on the issue of spending and deficits.
It is very strange that a Keynesian like Krugman seems to down play Keynes’ own arguments on the role of business expectations in determining investment decisions.
Are, now, businessmen not subject to uncertainties and perceived “dangers” of future taxes, possible inflation, and burdensome regulations being implemented by government, so these things do not influence their investment and employment decisions today?
Or are we locked into an other variation of Keynes’ own thinking that claimed that businessmen only determine employment and investment decisions based on current revenues resulting from “aggregate demand,” so those uncertainties of the future play no part in their current decisions other than unexplainable “animal spirits”?
Your observations on Krugman’s views, and those of people like Don Boudreaux’s frequent criticisms in his daily email messages, apparently have no impact.
Krugman seems to live in his own intellectual world, impervious to either reason or experience. His way of arguing is what can give “a priorism” a bad name.
Richard Ebeling
Krugmanian a priorism is more “daring” than anything Mises ever thought of.
I don’t understand. Why do expected tax increases reduce current spending?
Only if people saved by trying to increase cash balances (not matched by an increase in the money supply) would total spending decline.
Lee Kelly,
Is your question a joke? If taxes were tripled, what do you think would happen to spending on vacations and luxury goods (for exanmple)?
And while we’re at it, what do you think would happen to stock prices (for example) if corporate taxes were tripled?
Just asking.
(Hint: go to valuepro.net and experiment with your own tax rates and stock prices.)
Allan Meltzer addresses Lee’s question in tomorrow’s Wall Street Journal.
http://online.wsj.com/article/SB10001424052748704629804575325233508651458.html?mod=WSJ_Opinion_LEADTop
In my view Krugman is either a cynic or a true believer. In the second alternative evidence will simply ratify his vision that intervention was, as he has said several times, insufficient to create the required aggregate demand. In the first option, he is simply covering his rear.
As I recall, the fiscal stimulus was supposed to prevent the unemployment rate going over 9%. Unemployment is now about 10.5%!
I supposed the revised counter-factual is whatever the unemployment rate is now plus a few percentage points because the unemployment rate would have always been worse but for the fiscal stimulus.
This counter-factual fails Popper’s definition of a science. The effectiveness of the fiscal stimulus can never be falsified empirically because the counter-factual is continually revised up or down.
This all reminds of Friedman’s review of the Fed’s annual reports in the 1920s and 1930s.
In the good times, the prosperity was the product of the Fed’s good monetary policy management.
In the bad times, the recession would have been far far worse but for the Fed’s deft use of the very limited policy tools at hand.
Krugman’s is not apriorism, it is ideological true-believerism, either sincere (Krugman believes what he says) or insincere (Krugman thinks repeating the same mantra over and over again is effective in pursuing his political goals of further extending the US socialdemocracy).
In the latter case, Henry Frankfurt, an American philosopher, has written a book on the role of indifference toward truth in the public debate, and called his book with a purely technical term: “bullsh*t” (I also use it technically, not as a derogative term).
From a descriptive point of view, Krugman ignores, or feigns ignorance of, Cole and Ohanian’s (and Rothbard’s, and Chester Phillips’s…) view that government-sanctioned wage rigidities was the cause of the Great Depressione, capable, in conjunction with a monetary crisis, to stop the whole market from working properly. Without Hoover, no Great Depression would have ensued, and in fact none else ever ensued in the XX century. Without Roosevelt, unemployment would have been a short term phenomenon. The Great Depression’s importance is grossly overrated.
A much more fitting parallel could be done with the other twenty years crisis: Japan’s. Fiscal and monetary policies failed, a corrupt, inefficient and unsustainable financial system survived the crisis, trillions of yens were wasted in useless endeavors, and savings flew out of the country because of carry trade, halting the recovery.
PS What’s the relevance of New-keynesian models in understanding Japan’s crisis? Almost nil. They need to postulate that real equilibrium rates have been negative for twenty years in a row to fit the data. If they postulated a divine intervention new-keynesian economics would be a higher form of science.
Mario,
You wrote: “Does Krugman ever acknowledge the real controversy over whether the first (Bush) and second (Obama) stimulus packages had any substantial effect?”
Yes. He claims they were too small 🙂
Thank you Dr. O’Driscoll for the heads-up on the Meltzer piece. I thought it was a superb Higgsian Regime Uncertainty assault on Krugman (not by name).
http://online.wsj.com/article/SB10001424052748704629804575325233508651458.html
von Pepe,
You’re welcome.
Allan Meltzer has been superb on the crisis. He has also a paper in the current Cato Journal summarizing the findings of his 3-volume history of the Fed.
Bill,
The idea of a fiscal stimulus is to increase velocity (i.e. decrease money demand). The argument is simple. Money demand increases because of a relative rise in the risk of holding other assets. The government, by issuing bonds, can increase the supply of an alternative low risk asset. So long as the government can then spend the money it receives for bond sales faster than the money would have been spent otherwise, the demand for money declines and–centaris paribus–total spending rises. At least, this is my limited understanding of the matter.
The argument proposed by many fiscal stimuli opponents is that when government issues new bonds there are unintended consequences, i.e. the centaris paribus assumption does not hold. In anticipation of higher taxes in the future, people reduce their expenditures in the present. That is, any attempt to increase velocity with a fiscal stimuli inadvertantly increases the incentive to hold money, thus the net effect on total spending is, at best, unclear.
But I don’t think this argument makes sense. So long as people are saving by purchasing other assets or bank liabilities, then why would total spending decline? Only if people save in the form of money and the supply of money is inflexible would this offsetting occur. I don’t like fiscal stimuli, but I dislike flawed arguments against fiscal stimuli even more, and this seems to be one of them.
I grant that the composition of total spending may change, and I also dislike the prospect of higher taxes. In any thorough analyses of the costs and benefits of fiscal stimuli these should be considered, but on the matter of short run consequences for total spending, they do not seem particularly relevent.
Lee,
You have just provided a textbook case of how Keynesian hydraulics is wrong and assumes people are stupid.
In your (incomplete) restatement of intermediate macro, government spends money more reapidly than would the public, so velocity increases. If that is your mechanism, then it is a one-time, knockoff effect. In every version I’ve heard, however, government spending is supposed to stimulate additional private spending (hence the word stimulus, or pump-priming).
Now we must assume consumer-taxpayers are stupid. They spend in some frenzy w/o regard to the future consequences (i.e., taxes). This is not an issue of ceteris paribus, but violating the assumption of rationality (consumers match means to ends).
You also leave out the price mechanism that is supposed change people’s demand for money, i.e., interest rates. I can understand why you did so, since the interest rates of the model aren’t behaving as predicted (rates on government bonds are falling not rising).
For the rest of your argument, every point that Mario raised seems to have sailed passed you.
In additon to Jerry’s points, one thing that rarely gets mentioned (Meltzer didn’t say it in today’s WSJ op-ed, at least not explicitly) is that government spending is spent on things demanded by politicians (like bridges to nowhere; and sayonara Robert Byrd) and bureaucrats instead of by consumers.
And let’s not even get into greater politicalization of the economy that all too often comes with more government spending. Of course this is highly desired by political types. It potentially gives them more shots to call and lives to rule.
I hope I have earned my Krugman-bashing credentials to be able to say:
(1) He actually has been zinging “our side” in some respects with his arguments about interest rates, I think. It is a bit awkward to be warning of unsustainable deficits as Treasury yields not only are low, but actually have been falling. (Granted, I think it’s flight from Eurozone, not an endorsement of Obama, but it’s still awkward.)
(2) He does take on “freshwater” opponents, and in my opinion blows them up. Guys like Cochrane really have been sloppy. I agree with their conclusions, in the grand scheme, but they’ve been doing sloppy stuff like mixing up a deficit-financed tax cut (holding G constant) with a deficit-financed boost in G. Ricardian equivalence might apply to the former, but not the latter.
I think Krugman is too glib when it comes to dealing with the Austrians, but I think he holds his own when taking on the Chicago guys. I mean c’mon, Fama saying we weren’t in a bubble, and by the way, he doesn’t even know what “bubble” is supposed to mean? No wonder so many people think Krugman is the real deal.
Pietro M.,
You are more right than you know in thinking the New Keyneseans believe in divine intervention. I’ve been playing with the idea that outright socialists are in effect social creationists (with Rational Man put in place of God), while interventionists, including of course the Keyneseans (New and Old), being social intelligent designers. It’s like that old phyiscs cartoon:
Bill Stepp and others I know I am late for an answer on the “expected tax increase” effect on current consumption but here it is.
“Sales tax” or better “Value added tax”
So what would happen if you expect a raise of a VAT in the long term. You would drop saving (we are in a liquidity trap 🙂 to spend now (we are under potential 🙂
Here is a kick start of private demand