Paul Krugman and the Permanent Slump

The Greatest and Most Important Living Economist is reduced to wild conjecture in a vain attempt to explain away the fact that no amount of stimulus is working as expected anywhere in the world.

[I]f Mr. Summers is right, everything respectable people have been saying about economic policy is wrong, and will keep being wrong for a long time. Mr. Summers began with a point that should be obvious but is often missed: The financial crisis that started the Great Recession is now far behind us. Indeed, by most measures it ended more than four years ago. Yet our economy remains depressed.

He then made a related point: Before the crisis we had a huge housing and debt bubble. Yet even with this huge bubble boosting spending, the overall economy was only so-so — the job market was O.K. but not great, and the boom was never powerful enough to produce significant inflationary pressure. Mr. Summers went on to draw a remarkable moral: We have, he suggested, an economy whose normal condition is one of inadequate demand — of at least mild depression — and which only gets anywhere close to full employment when it is being buoyed by bubbles.

I’d weigh in with some further evidence. Look at household debt relative to income. That ratio was roughly stable from 1960 to 1985, but rose rapidly and inexorably from 1985 to 2007, when crisis struck. Yet even with households going ever deeper into debt, the economy’s performance over the period as a whole was mediocre at best, and demand showed no sign of running ahead of supply. Looking forward, we obviously can’t go back to the days of ever-rising debt. Yet that means weaker consumer demand — and without that demand, how are we supposed to return to full employment?

Again, the evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing.

It’s really quite remarkable what lengths reasonably intelligent people will go to in order to hold onto their conceptual models while ignoring the obvious. The idea that “population growth” is responsible is obviously ridiculous in light of the vast number of people out of work; older people consume considerably more than younger people with no money do anyhow.

The mainstream economists are flailing around with no answers, completely ignoring the fact that this is the very problem of excess credit that was predicted for decades by those whose models take it into account. We’re not mysteriously trapped into a normal state of mild depression, we’re simply choked with debt, government interference, and debt-based malinvestment.

The debt has to be cleared from the system. There are two ways out. Hyperinflation or debt-default. The latter is the better, wiser, and safer choice.