Friday, December 30, 2011

Krugman at it Again

I have just read an article by Paul Krugman, that yet again defends Keynesian economics. It would be amusing were it not taken seriously by so many. Let's take a look at the kick-off:

“The boom, not the slump, is the right time for austerity at the Treasury.” So declared John Maynard Keynes in 1937, even as F.D.R. was about to prove him right by trying to balance the budget too soon, sending the United States economy — which had been steadily recovering up to that point — into a severe recession. Slashing government spending in a depressed economy depresses the economy further; austerity should wait until a strong recovery is well under way.
One small detail, Professor Krugman. Keynes, unless I am mistaken, did not propose that deficits were also run during the 'good times', but that was the situation of many of the economies in the run up to the economic crisis. These deficits were not the only stimulus; there was the rapid expansion of credit in both the consumer and business spheres. I do not think that Keynes had in mind that growing government deficits were a good thing during the good times, and I very much doubt that his response to a debt bubble would be to continue the growth of the bubble, for example replacing growth in consumer debt with growth in government debt. Even if accepting Keynesian economics (which I do not), then this is nothing to do with Keynes, except in regards to ignoring his wider context.

Professor Krugman later argues that there was no real fiscal stimulus, due to state cuts in spending, and suggests that the stimulus was not enough. He then argues:

So the real test of Keynesian economics hasn’t come from the half-hearted efforts of the U.S. federal government to boost the economy, which were largely offset by cuts at the state and local levels. It has, instead, come from European nations like Greece and Ireland that had to impose savage fiscal austerity as a condition for receiving emergency loans — and have suffered Depression-level economic slumps, with real G.D.P. in both countries down by double digits.

So the US government is not borrowing and spending on a scale that can only be comparable to World War II? I mean really? What is happening is that the government is borrowing at record rates already. Is this not a massive government stimulus? Not to mention the massive stimulus of printing money, and ongoing targeting of record low interest rates. Also, he is comparing the current government borrowing with previous levels of borrowing in the good times, when there should have been no borrowing at all. In other words, the economy was already structured around servicing consumption of government borrowed money, even before the economic crisis struck.

As for the problems confronting Greece and Ireland, these are just the illustration of the problems of too high deficits. Nobody wants to lend them money. People operating in the bond markets simply doubt that they will ever get their money back if they invest in these countries. Krugman appears to address this argument (emphasis added):

Now, you could argue that Greece and Ireland had no choice about imposing austerity, or, at any rate, no choices other than defaulting on their debts and leaving the euro. But another lesson of 2011 was that America did and does have a choice; Washington may be obsessed with the deficit, but financial markets are, if anything, signaling that we should borrow more.
What Krugman is mistaking here is the fleeing of investors into the $US as a safe haven, as a winner in the 'least ugly' contest for money. However, his argument is investors want the US to borrow more! He ignores the fact that it is quite possible that the US might actually lose the least ugly contest if the US were to grow the rate of debt accumulation. He also ignores the fact that bond yields have been held down through money printing, and that any appreciation in US bond yields would see more money printing to keep the yields down. Just the promise of more money printing will, of itself, keep yields lower. He goes on to say that (again, my emphasis):
Again, this wasn’t supposed to happen. We entered 2011 amid dire warnings about a Greek-style debt crisis that would happen as soon as the Federal Reserve stopped buying bonds, or the rating agencies ended our triple-A status, or the superdupercommittee failed to reach a deal, or something. But the Fed ended its bond-purchase program in June; Standard & Poor’s downgraded America in August; the supercommittee deadlocked in November; and U.S. borrowing costs just kept falling. In fact, at this point, inflation-protected U.S. bonds pay negative interest: investors are willing to pay America to hold their money.
And if the Euro crisis was not taking place? Let's imagine a world in which there is financial stability, that sovereign debts in Europe are sustainable, that the Japanese economy is sound and so forth. If investors were to then look at the US, I think that there would be huge flight of capital. And this is the point; in the reality of today, where might the capital fly to? Yes, Professor Krugman, the US has managed to continue to accumulate debt without any major problems so far. It is not because purchasers of bonds want the US to issue more debt, but they simply cannot think of anything else to do with their money. If there were new measures that saw an increase in the rate of debt accumulation, it would simply test the status of the US in the least ugly competition. It is not a test that would be advisable.

Also, how much is enough borrowing, Professor Krugman? At present, the borrowing of the US government is at record levels. How much is needed, and for how long? What is the point at which the borrowing becomes counter-productive/unsustainable? Does it ever? At what point will taxes need to be raised to cover the borrowing? Or are you proposing that borrowing now will not mean high taxes later (in which case, the borrowing during the boom times should have led to a great boom now)? Where are all the answers to the basic questions?

It seems to me that simply saying borrow and spend more is fatuous argument. Yes, if you borrow and spend more, employment will increase (or decrease less), economic activity will increase, and the economy may even appear to grow if you borrow and spend enough. At the same time, the economy will structure around servicing that debt based consumption, entrenching the necessity of accumulating more debt. This is the history of Greece. The trouble is that, this only works as long as people are willing to fund the debt. The Greeks got away with it for a long time under the false premise that they were as sound as other members of the EU. Then it was apparent they were not. All that has happened since is that we can now see the real size of the Greek economy when debt accumulation slows down. Therefore, my final questions for Professor Krugman are; how big is the US economy when debt based consumption is removed? Or does he believe that debt based consumption is a productive part of the economy? Does he believe spending borrowed money creates real economic growth, or an illusion of growth that is dependent upon the ongoing accumulation of more debt?


  1. Nice post over at Steve Keen's Debtwatch on the topic of British debt levels:

    Apparently financial sector debt alone is 250% of GDP (or more).

  2. Krugman calling for a housing bubble in 2002:

    Death to Bubble Addicts

  3. I just stumbled across this blog and think his points really echo yours about regulation.

    Thought you might be interested!

    Keep up the good work, as always I look forward to reading your next article

  4. anybody who is looking for a summary of the numbers engulfing the United States, this site proves useful time and time again. note the amount of liabilities for each US household through tax and the fact that 50% of americans don't pay tax!

    “The federal government’s total liabilities, unfunded obligations, and commitments and contingencies grew to over $65 trillion, an increase of over $4 trillion in one year!”


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