Tag: books

In Chapter Two, Depression Economics, Krugman resorts to his favorite analogy, the babysitting coop, whose travails were chronicled by a 1977 article in the Journal of Money, Credit and Banking.  This is at least the third book in which he has resorted to the analogy, this time to demonstrate that overall lack of demand can’t hurt the economy and that “your spending is my income and my spending is your income.”  But this time, he also cites the 150 babysitting couples as an example of his proposed cure for the global economy

“That’s where we come to the third lesson from the babysitting co-op: big economic problems can sometimes have simple, easy solutions. The co-op got out of its mess simply by printing up more coupons.

This raises the key question: Could we cure the global slump the same way?  Would printing more babysitting coupons, aka increasing the money supply, be all that it takes to get Americans back to work?

Well, the truth is that printing more babysitting coupons is the way we normally get out of recessions. For the last fifty years the business of ending recessions has basically been the job of the Federal Reserve, which (loosely speaking) controls the quantity of money circulating in the economy; when the economy turns down, the Fed cranks up the printing presses. And until now this has always worked. It worked spectacularly after the severe recession of 1981–82, which the Fed was able to turn within a few months into a rapid economic recovery—“morning in America.” It worked, albeit more slowly and more hesitantly, after the 1990–91 and 2001 recessions.

But it didn’t work this time around. I just said that the Fed “loosely speaking” controls the money supply; what it actually controls is the “monetary base,” the sum of currency in circulation and reserves held by banks. Well, the Fed has tripled the size of the monetary base since 2008; yet the economy remains depressed. So is my argument that we’re suffering from inadequate demand wrong?

No, it isn’t. In fact, the failure of monetary policy to resolve this crisis was predictable—and predicted. I wrote the original version of my book The Return of Depression Economics, back in 1999, mainly to warn Americans that Japan had already found itself in a position where printing money couldn’t revive its depressed economy, and that the same thing could happen to us. Back then a number of other economists shared my worries. Among them was none other than Ben Bernanke, now the Fed chairman.

So what did happen to us? We found ourselves in the unhappy condition known as a “liquidity trap.””

Krugman’s first claim is harmless enough.  Obviously, an overall lack of demand can hurt the economy, those who erroneously insist that supply is always capable of creating demand notwithstanding.  His second claim is partially true, but incomplete, because not all spending comes from income.  A considerable amount of spending also comes from credit, but since that is neither part of the Neo-Keynesian aggregate model nor the babysitting coop story, Krugman simply omits it.  And it can’t be denied that the babysitting coop did appear to get out of its impasse by printing more coupons.

However, Krugman is guilty of a significant omission when he claims that Fed inflation – cranking up the printing presses – worked spectacularly in ending the 1981-1982 recession.  And what he omits is that one of the chief causes of the recession was the Fed’s need to slam on the brakes due to the rampant inflation of the 1970s, inflation that completely failed to cure the high rates of unemployment as it was supposed to according to conventional Neo-Keynesian economic theory.  In fact, it was this failure that led to the widespread rejection of Neo-Keynesianism and the adoption of Milton Friedman’s monetarist spin on it.

Also, when Krugman claims that the Fed was cranking up the money presses in 1983, he omits to mention that throughout that year, which more than covers his “few months” the interest rate never fell below 10.5 percent, which is higher than it was at any time after November 1978!  Somehow, we’re supposed to believe that observably tighter monetary policy amounts to cranking up the money presses!

That being said, the money supply did observably begin increasing in 1983.  From mid-1982 to mid-1983, M2 rose $228 billion.  However, L1, total credit, grew $598 billion over the same period.

Now, Krugman admits that tripling the monetary base has not succeeded in moving the economy out of depression.  If the true lesson of the spring 1983 expansion is that credit, and not money supply is the issue, then we can assume that the current dearth of economic growth should be correlated with a similar lack of growth in Z1.

As it happens, that is precisely what we see.  Z1 has been very nearly flat since 2008 and is currently $5 trillion lower than its 60-year historical rate of growth would predict.  So, the basic foundation for Krugman’s case is not only incomplete and historically inaccurate, but flawed in precisely the way that those familiar with the Neo-Keynesian model would expect.

Paul Krugman has the solution to the economic crisis in his book published earlier this year.  You’ll never guess what it is!

Spend Now, Pay Later

The basic situation of the U.S. economy remains now what it has been since 2008: the private sector isn’t willing to spend enough to make use of our full productive capacity and, therefore, to employ the millions of Americans who want to work but can’t find jobs. The most direct way to close that gap is for the government to spend where the private sector won’t.
There are three common objections to any such proposal:

1.    Experience shows that fiscal stimulus doesn’t work.
2.    Bigger deficits would undermine confidence.
3.    There aren’t enough good projects to spend on.

I’ve dealt with the first two objections earlier in this book; let me briefly summarize the arguments again, then turn to the third.

As I explained in chapter 7, the Obama stimulus didn’t fail; it simply fell short of what was required to offset the huge private-sector pullback that was already under way before the stimulus kicked in. Continuing high unemployment was not just predictable but predicted.

The real evidence we should be considering here is the rapidly growing body of economic research on the effects of changes in government spending on output and employment—a body of research that relies both on “natural experiments” such as wars and defense buildups and on careful study of the historical record to identify major changes in fiscal policy. The postscript to this book summarizes some of the major contributions to this research. What the work says, clearly and overwhelmingly, is that changes in government spending move output and employment in the same direction: spend more, and both real GDP and employment will rise; spend less, and both real GDP and employment will fall.

What about confidence? As I explained in chapter 8, there’s no reason to believe that even a substantial stimulus would undermine the willingness of investors to buy U.S. bonds. In fact, bond market confidence might even rise on the prospect of faster growth. Meanwhile, both consumer and business confidence would actually rise if policy turned to boosting the real economy.

One would probably have to read this book to believe the astonishing simplicity of his Neo-Keynesian approach.  I could have written it in in a single page.  Actually, I could have written in in a single sentence: More public debt and more government spending is the solution to this economic depression because government spending is capable of creating the jobs necessary to produce economic growth, while the resulting public debt is not a problem because any country with its own central bank can issue an infinite amount of it without any long-term costs.

I think what we are seeing here is the beginning of the death throes of Neo-Keynesian economics.  They can’t assert that debt doesn’t matter at all anymore, since the conventional Samuelsonian argument was blown away by the growth of foreign debt and the financial crisis of 2008, so now Krugman and company have shifted to arguing that a certain and specific type of debt can be amassed infinitely.  Time will soon prove this move of the goalposts to be false as well.

There is a lot to question in Krugman’s book and I will be addressing those questions over the next few weeks as I have 16 sections bookmarked.  But this is the essential summary.