He Told You So
Paul Krugman's influence on American politics has become indispensible. At the same time, like most macroeconomists, he can underestimate the technological (read, entrepreneurial) revolution that's hit the real economy in recent years--you know, the business innovations whose details that other Times columnist sweats. It is clear from his work that government must (in Adam Smith's phrase) "facilitate commerce in general." But it is not always clear how. My review in The Nation of his prophetic book from 1999, The Return of Depression Economics, can be read here.
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Recently, Krugman and Summers have become worried about the economy (the world economy?) entering into a deflationary trap. Sadly, both have abandoned macroeconomic prescriptions for kitchen-table nostrums (mainly, inadequate and pusillanimous government job creation programs).
Worldwide, the "money supply" is collapsing ("debt destruction"); worldwide, people, sensing a new economic Ice Age is upon us, are saving their money in the hope of getting through the hard times (the "paradox of thrift" and the associated fall in money velocity). And so, we head toward deflation and a threatened spiral in which increased savings reduces the money available to repay debt, and the debt unpaid (destroyed) induces people to save more.
The answer is simple: Give the people enough money ("print" it and hand it to them) to comfort them such that their panic will subside and they'll return to rational buying and spending patterns.
It's up to the macroeconomists to determine how much money should be printed and over what period of time it should be distributed. If they can't do it, then, what good are they?
N.B. The Sweeneys laid this out thirty years ago and Krugman, presumably, knows it.
February 6, 2009 7:25 AM | Reply | Permalink
One prophetic book that I think should get the Krugman re-issue treatment is "Work Of Nations." One thing that changed since Reich's book is that China took on the role that Reich saw for Japan. But though the details need updating, the theme is right on and perfectly captures how we can have a global slowdown that we can't export our way out of. It also, sadly, shows why "Buy America" provisions to the stimulus bill will be ineffective.
February 6, 2009 8:14 AM | Reply | Permalink
Here's the problem, Krugman is not a macroeconomist. His work, his nobel is in trade economics. Now I like him and I think he has some good ideas. However, just because he has a bully pulpit I'm not so sure he right about something in which he has no strong experience.
In the end he is just part of the theory that if you put 100 economists in a room ask them to solve the same economic problem you will get 101 different ways to go.
February 6, 2009 8:18 AM | Reply | Permalink
Great editorial, Professor Avashai. Thanks. Krugman's column in the NYT this morning was particularly good: http://www.nytimes.com/2009/02/06/opinion/06krugman.html?_r=1&ref=opinion&pagewanted=print and the money quote was this:
(And he thinks the stimulus is not large enough.)
I don't presume to have enough economic understanding to venture very far into these dangerous waters, so I'm putting my trust in people like Krugman. Let's hope that there are enough members of Congress who do so as well, so that we're able to avert the worst of the crisis.
February 6, 2009 9:00 AM | Reply | Permalink
Let me assure you that you are smarter about economics than you think. Essentially all of economics can be analogized to individual everyday experience. Balanced budgets, trade deficits, taxes, and job growth, are things we all deal with.
Now, consider Krugman's evaluation of our problem...
and from the same column part of his solution....
Now ask yourself, what in the world does sending money to state and local government do for any of the people you do business with? Does it help grocery stores? Hardware stores? Car dealerships? Home buyers? Anybody besides bureaucrats in offices? No it doesn't.
Let's go a step farther. Let's imagine a dollar sent to Washington in tax. Every dollar contributes to bureaucratic overhead( salaries, rent, entertainment, transportation, etc), so it shrinks before even being applied to anything useful. Now imagine that shrunken dollar sent to states, which takes a piece for it's overhead, and then counties, which takes a piece for it's overhead, and then cities, which takes a piece for it's overhead. Estimates vary, but by this time your original dollar has only 30-70 cents left to it. And then it's given to a teachers union to study how education works.
Or you could keep the dollar and use to buy something useful like food, clothing, or a car. Is there any question as to which scenario is more beneficial to business and the economy? Of course not, which makes you smarter than Krugman.
Yes, it IS just that simple, and don't let anyone tell you otherwise. Anyone that can't reduce an economic problem to simple, understandable, terms either doesn't understand the problem or is trying to baffle you with BS.
February 6, 2009 10:11 AM | Reply | Permalink
Well, it may be that simple, but I think you are willfully ignoring some important things about that dollar in tax.
You say that it contributes to "bureaucratic overhead (salaries, rent, entertainment, transportation, etc.)" - well, of course! But the money spent on all those things not only create jobs (somebody has to manage the properties, provide the entertainment and transportation), plus the salaries will be spent (I don't know anyone who gets a salary that doesn't have to spend money on food, housing and entertainment), which also contributes to jobs and the economy. That money is going into the hands of business owners and employees of those businesses, where it will in turn be spent.
Now, when what is left goes to the states, it does the same thing - it's paying salaries, which puts money in people's pockets, which they will then spend. And ultimately, when the state spends it on roads, or schools, it will again generate jobs, and demand for goods.
Read Robert Reich's post Senate Republicans and the Stimulus: Playing Politics When the Economy Burns. There's a very good chart in there about the effect on GDP of tax cuts vs. government spending. Educate yourself.
February 6, 2009 10:54 AM | Reply | Permalink
February 6, 2009 12:53 PM | Reply | Permalink
Whoa, shooter242!
The object of the "stimulus" bill is to keep the money supply from crashing. We need to "print" money and get it out there in the economy.
If you don't think that we're threatened by deflation or you don't think deflation's something to be feared, then, argue away.
If you accept the idea that deflation is a worry but think that there are better and more efficient ways of transmitting/spending* that new money than what the Congressional Democrats have come up with, have at it. But let's not spend time niggling over some transmission inefficiencies.
* Keynes' digging holes, salting them with dollars, backfilling the holes, and digging the dollars back up, for example?
February 6, 2009 10:58 AM | Reply | Permalink
We're in a liquidity trap. Shoveling more money into the system isn't going to help. What we need is monetary velocity, and that isn't going to happen until the economic psychology is reversed.
Yes, we are in a deflationary phase, and until people are convinced to take risk rather than hoard it will stay that way. Legislate a large cut in capital gains taxes, or a moratorium for a year or two. It worked for Clinton, it will work for Obama.
As an aside, I'm thinking that relying on the Feds to solve our problems, is the real problem. As long as individuals expect someone else to take care of crisis, the natural tendency is to hunker down till the storm passes. But, the storm is actually the sum of people hunkering down. It's catch 242.
The specter of Government looming over risktakers and job producers, sucking out their capital and giving it to non-productive entities is guaranteed to shrivel growth. I've had a business. Right now I'd be thinking about who I could lay off, and whose bill I could be late on, not expansion. There is absolutely no reason to take a risk in this environment.
February 6, 2009 12:19 PM | Reply | Permalink
You dumb fuck.
Income inequality is the real problem.(hat tip Grand Moff Texan).
That chart was made by a Moody's analyst, who is a Republican, and was one of John McCain's economic advisers through the recent Presidential campaign and election.
Take the crack out of your pipe and smoke that instead.
The haves, the have-a-littles, and the have-nots.
You can have the federal government solve it, or you can have a bloodbath.
FDR saved laissez-faire from itself.
Absent removing the 2nd amendment, capital gains cuts won't help in the short or long-term.
February 6, 2009 1:17 PM | Reply | Permalink
February 6, 2009 1:31 PM | Reply | Permalink
shooter,
it isn't what it makes kenga, its what it makes you. heh heh
February 6, 2009 3:08 PM | Reply | Permalink
FDR saved laissez-faire from itself.
Laissez-faire did not cause the Depression.
The Federal Reserve did.
February 6, 2009 8:34 PM | Reply | Permalink
See, below.
February 6, 2009 1:39 PM | Reply | Permalink
shooter says;
"Hoarding" is a frame of mind, perhaps in this case brought on by fear of risk. If you instituted a cap gains tax how would that discourage people from hoarding? Wouldn't they just hoard the cap gains tax cut?
February 7, 2009 10:58 AM | Reply | Permalink
With respect, I would point out that your first sentence in the paragraph is totally contradicted by the second.
The real difficulty in a recession like this lies in the fact that our needs right now are counter-intuitive. It is only the fool among us who continues profligate spending when all indications and forecasts show that we have need to save money and pay off debt instead if we are going to survive this recession.
Yet, spending money into the economy is PRECISELY what is required if it is ever to recover. And so stands the reason to look to the government as the "spender of last resort" to do what is required for the overall economy while we as individuals retreat from the consumer market to get our own houses in order.
Don't feel too badly about getting this wrong, however. The GOP caucus seems to suffer greatly under the same misconception, and they are required to know better.
February 6, 2009 11:49 AM | Reply | Permalink
See, it's statements like this that make me want to tune out people who utter them.
Why? My time would be more productively spent watching Spongebob.
Why is that?
Because it is a clueless assertion, and it suggests the speaker doesn't understand what they're talking about.
Every part of it is demonstrably false.
Or, if it's not clueless, it is either fundamentally delusional(aka crazy) or dishonest. Ignorance, insanity, dishonesty - those are the only 3 possible geneses of such a statement that I am aware of. (No, I don't buy that you heard it from Xenu, either.)
Do people involved in grocery stores - the owners, the managers, the employees, the suppliers, the customers - do they use public services?
Uh, yeah, every single one of them, every single day, including days off.
They drive on (pothole-ridden, in my area) roads to get to there - roads that were publicly constructed, and are publicly maintained and repaired(or not, due to budget cuts).
(I myself just had to spend some of my hard-earned $ to repair a rim and tire that were nearly destroyed by a pothole - my share of the cost of paying for repair and maintenance is a lot lower than what I paid out of pocket to fix it. If the city had the money in budget to keep the roads fixed, I wouldn't have blown that tire. Unfortunately, with local and state revenues down, one of the cuts has been to the public works budget. So I can reasonably expect that this problem will get worse, not better, absent increased money in the budget. Heck, we're nearly out of snow removal money - any idea what will happen to the local economy if no one can get to work? And I've got news for you - the companies in my area affect yours too, so there will be a ripple effect.)
Those same streets are used by the publicly funded fire departments and ambulances that respond to the occasional heart attack, seizure, or birth at the grocery store.
And by the publicly funded police who respond to robbery attempts, shoplifting incidents, and muggings in the parking lot.
One can also find it easy to imagine that car dealerships would have a hard time finding customers if there were no roads - though it's more likely the business wouldn't even exist, nor would the manufacturers of the automobiles.
Of course, driving in the cars, which publicly funded roads made possible would be a scary proposition if it weren't for the fact that a person can safely assume that almost all other drivers have had to pass a test to become licensed by the publicly funded RMV, and will follow the rules of the road established by the RMV and highway department, and enforced by the police.
All these also apply to hardware stores - or pretty much any business that retails a good or service.
And your home buyers, they have access to credit that allows them to not have to save the entire purchase price. The credit comes from deposits, made by other people. Of course, if it weren't for public deposit insurance programs, most of that credit would be hiding under peoples' mattresses. And they also have access to the courts, if the bank or seller cheated them in some fashion - courts that are, you guessed it, publicly funded.
Signing a contract for ANYTHING? The only reason that's possible is because there is an enforcement mechanism, in the form of publicly funded courts and law enforcement. If it were futile, no one would do it, and we know that they do.
Without the institutions, services, infrastructure and rules that are provided by a multitude of publicly funded entities, there would be no economy to speak of, much less one to bitch about.
February 6, 2009 12:59 PM | Reply | Permalink
February 6, 2009 1:46 PM | Reply | Permalink
Thick as a brick.
February 6, 2009 3:03 PM | Reply | Permalink
Yeah, because none of those people buy things like food, fuel, clothing, services. Every single one of which is provided by a business.(In case you aren't aware, people who receive public assistance also receive public services for free)
These are not investors, they are folks who are a single welfare payment from turning to crime to survive. Be advised that there are welfare recipients outside of DC, in communities that don't have Congress looking out for them.
Every single dime they get will be spent.
And businesses will be the recipients of those dimes.
Please note, too, we are not trying to stimulate business - we're trying to stimulate the economy, of which business comprises a fraction. It may be a significant fraction, but I'm told that consumer spending is about(heh - WAS) 70% of the economy.
In re: Zandi.
If it looks like a duck, and quacks like a duck, and walks like a duck, it's probably not a squirrel. His FEC listed contributions are 4 vs 2: Republican vs. Democrat. R for Presidential, D for Congress.
But, nonetheless, I stand corrected insofar as his declared party affiliation.
However, we definitely can't describe him as a partisan Democrat.
How you can describe him as a "government spending liberal Democrat", I don't get.
He works for Moody's, not the government.
His other employer and financially supported candidate was a small-government mavericky Republican.
Perhaps the issue is that he has dispassionately crunched some numbers to the best of his ability, and his conclusions contradict your own.
February 6, 2009 3:09 PM | Reply | Permalink
You might consider that Krugman is looking at the forest, while you are disappointed that he doesn't look more at the trees.
February 6, 2009 10:04 AM | Reply | Permalink
"Paul Krugman's influence on American politics has become indispensible."
Paul Krugman's commentaries are whispers in a hurricane.
The problem is not governmental or economic. The problem is human nature. There is no solution. The so-called stimulus is nothing but more of the same kind of theft that put us in this mess.
Lots of us wanted something for nothing, and we got nothing for something. Meanwhile the honest people who do the real work get dragged down along with the greedy ones.
February 6, 2009 12:40 PM | Reply | Permalink
As much as I disagree with the responses of Bush and Obama to the crisis -- past and threatened -- I can't agree with shooter242's complaints.
Firstly, the amount of money and its velocity are the Janus faces of money supply. Yes, velocity suffers when spending is reduced. The answer, though, is not to wring one's hands; it's to increase the amount of money in the economy.
Secondly, shooter242 identifies the reduced risk tolerance of almost all actors in the current economy. But as the Sweeneys pointed out thirty years ago, risk tolerance can be increased by threatening* inflation.
If there's even a small possibility of a deflationary spiral, remedies must be tried. The debate should be over which ones are most likely to succeed.
* The threat must be believable; but see, William Buiter for the argument that this government has no credibility -- that is, no one would believe the threat).
February 6, 2009 1:53 PM | Reply | Permalink
I agree with the basic idea of inflating our way out of this, but I think there's a problem with current market psychology that's getting in the way.
Everybody and their brother, (including me) has a finger on the button to shift over to gold, TIPS, and whatever else to get in front of the inflation that is inevitable. We're all trying to game the bottom and as a result there isn't a near term capitulation. It's a Mexican standoff.
I have the feeling this standoff could last years without a precipitating event, the oft mentioned "L" bottom. There are just too many smart people, getting too much information in real time. And all these people are looking many jumps ahead in the game, with decreasing volatility enforcing a slowdown of events.
Something will break the current logjam. I just hope it's not catastrophic. On the other hand, a slow acceptance of a new paradigm might be the most painless way out. As always, anything is possible.
February 6, 2009 2:16 PM | Reply | Permalink
"...a slow acceptance of a new paradigm might be the most painless way out."
Any of us can accept a new paradigm right now. But those most likely to accept a new paradigm are not in positions of power. Washington, Wall Street, and corporate heads will all squeeze dollars out of the middle class until no dollars are left to squeeze out.
The rest of us can adjust our philosophies, try to keep smiling, and be thankful for what we have, however little that is. We are alive, and that is a great gift.
February 6, 2009 3:33 PM | Reply | Permalink
. . . to get in front of the inflation that is inevitable.
My fear is that the "debt destruction" going on is so fierce and so humongous and the governments' responses (especially, the USG's response) are so misguided and so puny that we'll have deflation for years and years.
Which fear appears common and explains why everybody "has a finger on the button" but very few have pressed it.
February 6, 2009 5:24 PM | Reply | Permalink
Paying down debt is by far the most efficient way to stimulate the economy, because it frees the money supply while improving balance sheets. The most appropriate way to pay down that debt is to put into the hands of citizens in a progressive distribution.
-Yes-. I AM advocating redistribution of wealth. What is the point to concentration of wealth at higher and higher power multipliers? Political power and luxury at the disproportionate expense of most citizens and the nation as a whole.
The purpose of businesses is to gather more wealth than they distribute. Fine. But we need a counterbalance in the form of real, actual progressive taxation so that the government can spread money back to laborers. You can't expect someone to produce wealth if they're starving or otherwise in distress. We have to adjust this system so that it meets all of our citizens' basic needs.
February 6, 2009 3:52 PM | Reply | Permalink
The most appropriate way to pay down that debt is to put [money] into the hands of citizens in a progressive distribution.
-Yes-. I AM advocating redistribution of wealth.
Since I agree with Organus' prescription -- which if it is a "redistribution of wealth" is anathema to middle-class Americans and unlikely, in that guise, to be swallowed -- I want to think about whether the second statement is true.
Suppose we begin by adding up all the assets shown on the balance sheets of every individual, firm, and government (including the USG and the FRB) in the United States of America.
Let us further suppose that the total equals -- I have no idea; it's a WAG -- $60 trillion.
Finally, let us suppose that during the current crisis 10% of these assets are destroyed in the form of cancellation of debt (bankruptcies, mortgages walk-aways, write-downs, other forms of forgiveness, etc.).
Now, if the Federal Reserve Board "prints" $6 trillion and distributes that money -- even if the distribution is unequal (whatever that might mean) -- is a "redistribution of wealth" taking place, at all?
The "wealth" has already been lost. Do the losers have any right to complain when a separate, unrelated event, the distribution of money, takes place? And what would they be complaining about?
February 7, 2009 9:34 AM | Reply | Permalink
I have great respect for people like Krugman, Roubini and Schiff who were yelling from the roof tops that we were headed for a financial diaster one to two years before it actually happened.
Today Peter Schiff sends out a waring For President Obama.
www.goldseek.com
By: Peter Schiff, Euro Pacific Capital, Inc.
The intense scrutiny recently paid to my investment strategy in the immediate wake of the financial crisis of the last six months has unfortunately obscured the central element of my larger economic forecast. The standard line has been that although I was able to predict the crash, in the form of the housing collapse and the credit crunch, my expected fallout of a weaker dollar and global decoupling has been proven false. However, this assumes that the crash has fully played out. In reality, all we have heard thus far is the overture.
In 2008, the bubble economy that I had meticulously described years ago finally hit the pin that I knew was out there. The corporate losses, frozen credit markets and plunging home prices were the opening salvo in the unfolding economic crisis. However, the vast majority of air has yet to leak out of the bubble. As it does, the U.S. economic crisis will kick into a much higher gear. I have positioned my clients to withstand the full fury of the gale, and when it finally comes, the question “was Peter Schiff right?” will finally be answered.
Thus far, our economy has actually been spared the worst due to the temporary strength in the dollar and the recent desirability of our Government’s debt. These movements derailed the short-term performance of many of my investment recommendations (though clearly not to the extent alleged by my critics) and threw a life-line to the downing U.S. economy. The demand for U.S. Treasuries has led to one of the sharpest dollar rallies on record, which has helped bring about just as pronounced a decline in commodity prices. As a result, although consumer income has fallen, so too have prices and interest rates.
The stronger dollar gives the Federal Government plenty of cover to a pursue a policy of rampant monetary inflation in order to re-inflate the collapsing bubble. Even though the Federal Reserve has thrown trillions of new dollars into circulation, those dollars have actually gained purchasing power - contrary to economic law. This, along with inventory liquidations and going-out-of-business sales, has kept a lid on consumer prices. The continued, although misguided, appeal of U.S. debt has also made it possible for the government to garner cheap financing for its equally misguided and massive bails-outs and stimulus packages.
In addition to cushioning the blow for us, the dollar rally has exacerbated the pain abroad. As money has rushed to our aid it has created a global credit crunch. The rest of the world is not only dealing with losses on toxic U.S. credit instruments but is also shouldering the burden of financing our new borrowing as well. As foreign currencies have fallen, foreign consumers have not received as large a windfall as Americans have from falling commodity prices.
In effect, Americans have been using these life-lines to pull the rest of the world into the stormy seas. However, there are signs that those holding the lines are about to cast them adrift. The dollar rally has run out of steam, gold has clearly broken out, and commodity prices are moving back up. 2009 is already the worst year ever for US. Treasury bonds and foreign stock markets are once again outperforming ours.
This week President Obama claimed that failure to pass his economic stimulus bill will have catastrophic consequences for the U.S economy. The reality is the catastrophe will be far greater with his plan then without it. If the trends of January and early February of 2009 continue, the rug will be completely pulled out from beneath the U.S. economy, and the full cost of the President’s “economic depressant package” will be apparent to all.
If foreign capital does not continue to pour into Treasuries, interest rates and consumer prices in the U.S. will soar. At that point, we will finally be confronted with the real crises that I have long predicted. When the day of reckoning arrives our policy response will be critical. If we continue on the course our new President has mapped out, the catastrophe will far exceed the scope of any he hoped to avoid.
February 6, 2009 4:26 PM | Reply | Permalink
shooter242 contradictss himself and at the same time explains exactly why the federal stimulae are necessary.
(S)he doesn't want to give any money up to the government. In fact he wants to mostly hold on to everything (s)he's got along with many others, or even buy gold. This is the equivalent of putting money in the matress. The subsequent deflating economy would only reinforce their behavior.
Refined Keynsian economics has always been the best tool we have. Since most states are tied to balanced budgets against declining income, the general populace has decling income, and business has declining profits, it is for the federal government to open the spigot in a measured (if guessed) way to sustain the economy.
Ellen, as usual, has it right.
Reduced taxes or rebates to consumers or businesses is probably the least effective way to boost the economy, especially if they just use it to reduce debt or create a safety net, although that might help the banks a little. Domestic infrastructure renovation among the best, and, if stretched over a decent period, will ensure the economy staying on track rather than having a short uptick before reslump. Plus it employs many of those layed off by the housing slump. Who knows, they might even buy a car or two.
Confidence in the banking system and getting banks lending again is an entirely separate issue with mostly different remedies. It is also one that needs to be dealt with just as urgently.
If we hadn't had the profligate ("deficits don't matter") morons we had these last 8 years we'd be starting from a lot better place than we are.
February 6, 2009 5:04 PM | Reply | Permalink