Alice in Krugman-land

Our favorite Nobel-laureate has written a new NY Times column Depression Economics Returns. It is worth understanding this because a) Krugman's thinking is solidly mainstream in economics - don't confuse his partisan politics with his mainstream economics b) it is very likely the government is going to go along with some version of the Krugman program. I pick Krugman to critique because he happens to write clearly, and because of his elevated profile with the Nobel prize, particularly in the new political dispensation.

Let's start with:

We are already, however, well into the realm of what I call depression economics. By that I mean a state of affairs like that of the 1930s in which the usual tools of economic policy — above all, the Federal Reserve’s ability to pump up the economy by cutting interest rates — have lost all traction. When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly.

An economic layman might find it a bit puzzling that the recipe for getting out of economic trouble is the same as the one you use to get in trouble in the first place: abandon virtue, caution and prudence. It is just as well that Krugmanomics doesn't deal in questions of root cause: when the police arrive to break up the party that got totally out of control, they should inform the revelers that the cure for massive hangover is government supplied 120-proof liquor.

Now what happens if the current episode of abandoning virtue, caution and prudence, not to be confused with the previous episode that got us into the present predicament, leads to fresh new trouble down the road? Well, we will just raise interest rates - seriously, you didn't expect they would hand out Nobel prizes when you can't handle such trivial questions in economics, did you?

Finally, in normal times modesty and prudence in policy goals are good things. Under current conditions, however, it’s much better to err on the side of doing too much than on the side of doing too little. The risk, if the stimulus plan turns out to be more than needed, is that the economy might overheat, leading to inflation — but the Federal Reserve can always head off that threat by raising interest rates. On the other hand, if the stimulus plan is too small there’s nothing the Fed can do to make up for the shortfall. So when depression economics prevails, prudence is folly.

In November of 2002, Bernanke's biggest concern was how to prevent deflation, which arose from the bursting bubble of the late 1990s. The exact sequence of events that Krugman prescribes - first a massive credit & government spending binge, followed by inflation, followed by an increase in interest rates - happened between 2002-2006. Well, at least the Professor is consistent. Except that, we are at the long term horizon from the view point of policy in 2003, so by Keynesian logic, we should all be dead now.

To leave no one in any doubt, in this blog post, Krugman elaborates on what kind of actions the government should take now:

What’s the answer? Huge fiscal stimulus, to fill the hole. More aggressive GSE lending. Maybe a “pre-commitment” by the Fed to keep rates low for an extended period — that’s a more genteel version of my “credibly promise to be irresponsible.” And maybe large-scale purchases of risky assets.

More aggressive GSE lending! Really? Like interest-only option ARM mortgages for 110% of assessed value to anyone who can fog a mirror? Pre-commitment to keep interest rates low for an indefinite period? Oh wait ...

So what is the exit strategy for Krugman? When it would finally become prudent for the government to abandon imprudence? If we pile on even more debt to cure the problem of too much debt, what happens when that bigger-pile-of-debt starts to crumble?

Here is a prediction of my own: the Nobel prize in 2008 will be seen in hindsight as a moment of bankruptcy, the intellectual bankruptcy of mainstream economic thinking.

Comments

16 Replies to Alice in Krugman-land

  1. A robust middle class is the key to American prosperity and much else good, and this has been compromised greatly over the last 20 years. This may be due in large part to loose credit (poorer people fail to advance because they are satisfied/strangled by easy credit; richer people get richer through big bets on easy credit; and the sucking from both ends robs the middle class of the tools of simple prosperity (good schools, public transportation, pride of achievement through self-sufficiency, stable asset values)).Regardless of the root causes, the glorious bonfire that was the American middle class is now a flickering twig and, just as Professor Krugman fails to appreciate the difficulty of changing course in business, I think you may be failing to appreciate the difficulty of reviving that fire if it is accidentally allowed to die in the pursuit of a longer-term ideal.Therefore, as with most everything in life, this is not as easy as the binary "true" or "false" that your programmer fans like (and apply to great use in the artificial world of software). Here, if we take "promotion of the middle class" as our banner purpose, then perhaps it will guide (and end) appropriate stimulus measures. This is like saying "let's make a CRM package", not "let's make a database."

  2. A robust middle class is the key to American prosperity and much else good, and this has been compromised greatly over the last 20 years. This may be due in large part to loose credit (poorer people fail to advance because they are satisfied/strangled by easy credit; richer people get richer through big bets on easy credit; and the sucking from both ends robs the middle class of the tools of simple prosperity (good schools, public transportation, pride of achievement through self-sufficiency, stable asset values)).Regardless of the root causes, the glorious bonfire that was the American middle class is now a flickering twig and, just as Professor Krugman fails to appreciate the difficulty of changing course in business, I think you may be failing to appreciate the difficulty of reviving that fire if it is accidentally allowed to die in the pursuit of a longer-term ideal.Therefore, as with most everything in life, this is not as easy as the binary "true" or "false" that your programmer fans like (and apply to great use in the artificial world of software). Here, if we take "promotion of the middle class" as our banner purpose, then perhaps it will guide (and end) appropriate stimulus measures. This is like saying "let's make a CRM package", not "let's make a database."

  3. Wow! A critique of Keynesian economics with a decidedly Austrian economics bent! It's the Fed that got us into this mess. Abolish the Fed! Krugman's program is like trying to cure a heroin addict with more heroin. I guess killing the patient is a cure.Keep up the fantastic work.

  4. Wow! A critique of Keynesian economics with a decidedly Austrian economics bent! It's the Fed that got us into this mess. Abolish the Fed! Krugman's program is like trying to cure a heroin addict with more heroin. I guess killing the patient is a cure.Keep up the fantastic work.

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