In which it is explained how the three extant economic schools recommend dealing with the current crisis:
The failure of monetary policy has caused many economists and politicians to return to the Keynesian school, which primarily concerns itself with fiscal policy. Just as the Federal Reserve’s control of the price of money – the interest rate – is the primary tool of the monetarists, government spending is the primary tool of the Keynesians, or more properly, Neo-Keynesians, since even the biggest fans of John Maynard Keynes have been forced to acknowledge at least some of the fundamental flaws in his economic theories. The core of the Keynesian theory of economic contraction is a failure of demand to meet supply, or to put it more simply, people are refusing to buy enough stuff to keep the economy growing. This is why Neo-Keynesians like Nobel Prize-winner Paul Krugman worry about “the looming hole in the U.S. economy,” by which he means the difference between what could be produced by the economy and what will actually be bought.
Filling this gap is the purpose of the stimulus package; it represents the government stepping in to buy what consumers will not. In his column entitled “The Destructive Center,” Krugman fearfully cites the Congressional Budget Office’s calculation that this gap between potential supply and expected demand is $2.9 trillion over the next three years. His worries are based upon the idea that the $787 billion stimulus package which passed last week is only one-quarter the size it would have to be to fill the demand gap.
On a related note, the Mises Economics blog posts a link to an interesting interview with noted neokeyn Paul Krugman. The following exchange comes from the 14 minute mark:
CSPAN: Our next caller is from Urbana, Illinois.
CALLER: Hi, Thanks for taking my call. Mr. Krugman represents the Keynesian view of the economy and he was blindsided by this debacle. The Austrians, on the other hand, represented by Ron Paul, the Mises Institute, and Peter Schiff, did predict this. Now, they’re [the Keynesians] the ones who are given the role of getting us out of this debacle, but they didn’t predict it.
KRUGMAN: Um, tch, boy, tch, I don’t even want to go into the Austrian stuff. It’s, ah, it’s not major school. But look, um, I was, what can you say… uh, I was closer to this than, ah, the bulk of the people who were giving pronouncements about the economy. I saw the housing bubble, I saw the bursting of the housing bubble was going to be nasty. So, I don’t know what more to say. We can bring in Austrians, we can bring in whatever you want, but this is a classic crisis. This looks very much like what happened in the beginning of the Thirties. It looks like what happened in Japan. Those of us who did see those parallels are in better shape to hopefully find a way out than those who assured us everything was fine….
CSPAN: So the lesson is, whether it’s the tulip mania in Holland or the Internet mania here in the US, what can we take away from this, these bubbles?
KRUGMAN: Well, bubbles happen. Bubbles which people believe prices of assets only go up happen. Um, defective financial systems happen, banking crises, very much. We thought we had ended those but it turns out the banking system was not effectively regulated. So, um, but, this is bigger. The main thing to understand is that this is much bigger than the dot com bubble of the late nineties. This is on the same scale as the Japanese bubble of the late eighties and therefore is very, very serious.
Bubbles happen? Seriously, just… bubbles happen? And more regulation would have somehow prevented it? That response, above all, tells you everything you need to know about the intellectual bankruptcy of the neokeyns. I have no doubt that he doesn’t want to get into the Austrian stuff… nothing like an appeal to a nonexistent authority to avoid getting embarrassed. And are we seriously supposed to be impressed that he managed to discern the reality of the housing bubble in 2005? How very impressive, especially for a Nobel Prize-winner who failed to see either the dot com bubble or the credit crash until after the fact.
May 27, 2005: Remember the stock market bubble? With everything that’s happened since 2000, it feels like ancient history. But a few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses. I’ve never fully accepted that view. But looking at the housing market, I’m starting to reconsider.
Notice that Krugman didn’t manage to see how the housing crash would bring about the subsequent financial crisis, even though I had pointed out the probability three years before, as had many other Austrians.