Paul Krugman’s Certainty

By Mario Rizzo    

Paul Krugman’s latest opinion piece in The New York Times is one big non-sequitur. Consider the steps of his argument:  

1. Unemployment is expected by various forecasters to remain high.  

2. Recessions initiated by financial crises are followed by more extended periods of low output and high unemployment than garden-variety recessions.  

3. Unemployment is bad – it causes real human suffering.  

4. More government spending will alleviate both unemployment and reduced output.  

5. Larger deficits are not such a big problem because the costs will be more than offset by the benefits in greater income.  

A little bit of evidence is provided for the first three. But the fourth is just an assertion. Will greater stimulus spending shorten the length and lessen the severity of the recession? (Of course, the fifth is dependent on the fourth.)  None of the hand-wringing about the badness of the recession and its human costs is relevant to the argument if the remedy is either ineffective or counterproductive.  

Scientifically, this is an important question. But in the world of economic journalism it does not seem to matter.  

If his advice is accepted, and things get better, he will say “I told you so.”

If his advice is accepted, but things do not get better he will say, “It was not enough stimulus” or “Things were worse than we had expected.”

If his advice is not accepted, and things get worse, he will say “I told you so.”

If his advice is not accepted, and things get better, he will say “That would not have happened without the previous stimulus – we were just lucky this time.”  

It used to be said that you could teach a parrot economics. All you have to do is teach him to say “supply and demand.” But the pop Keynesians have improved matters. Now you just have to teach him to say “stimulus.”

3 thoughts on “Paul Krugman’s Certainty

  1. The man in the street seems to understand what eludes many economists: the stimulus is bunkum and the spending (deficits) is dangerous. Whatever the effects of stimulus in theory, what is occuring is massive income redistribution. (In other words, Jim Buchanan deserved his Nobel Prize.) Meanwhile, as pointed out yesterday by Meredith Whitney in an op ed in The Wall Street Journal, the Fed’s efforts at credit allocation have predictably failed. Credit is readily available to those who do not need it — large corporations — while small companies are being starved of it. Small firms create most new jobs and that helps explain why we will experience a jobless recovery.

  2. One of the important debates in macroeconomics – ‘crowding out’ – involves the competition between the private and public ‘sectors’ for loanable funds, with the argument for, claiming that the competition leads to higher interest rates. The argument against, points to the fact that large budget deficits seem not to be associated with higher interest rates, empirically speaking.

    In terms of the mechanics of financing the deficit, bond issues are raising the required funds, the theory being that by channeling investor funds away from cash holdings and into bond purchases, idle loanable funds that do not get reinvested in industry are not able to drag down aggregate demand. The danger must be that these cash investments would indeed be invested for productive purposes, rather than leading to lower output, via the Keynesian mechanisms.

    Perhaps with a deficit that is mainly about transfer payments and other Consumption items in place, what will actually occur is – initially, a brief boost in sales, via the run-down of inventories, but then an overall contraction of the economy takes place, as the dire effects of lower net investment overwhelm the extra ‘spending’. This depression of the economy would obviously lead to keeping interest rates low – the opposite of the crowding out thesis, in terms of the ultimate affects of the budget deficit on interest rates, but also contra to the pro-deficit argument in terms of the overall economic outcome.

    So i would suggest that the massive deficit could be seen as Consumption expenditure replacing Investment expenditure, and thereby depressing the economy (and ergo, not leading to higher interest rates) – or in consideration of the depreciation of capital, simply as capital consumption.

    There can be no worse scenario for an economy than one whereby capital is effectively being consumed. For me, it conjures pictures of an organism eating itself, until all that remains is a stomach!

    If capital consumption is in affect occuring now, a second round of ‘stimulus’ might result in the unemployment rate reaching the teens.

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