Paul Krugman has been one of the clearest and strongest advocates of fiscal stimulus to end the recession which we have faced since the credit crisis of 2008.
The basic premise of the book – ‘End This Depression Now!‘ is based on Keynesian analysis of a prolonged recession and liquidity trap. The basic argument is that there is a deficiency of aggregate demand in the US economy. This lack of demand has led to lower economic growth, higher unemployment and a growing cyclical deficit. But, we shouldn’t just shrug our shoulders and accept this. It can be overcome and we shouldn’t worry about government borrowing during a recession.
Or as Krugman writes:
..But don’t we have to worry about long-run budget deficits? Keynes wrote that “the boom, not the slump, is the time for austerity.” Now, as I argue in my forthcoming book*—and show later in the data discussed in this article—is the time for the government to spend more until the private sector is ready to carry the economy forward again
The initial response to the recession in 2008 was a rapid loosening of monetary policy and some fiscal expansion. But, then worried about growing budget deficits, Krugman argues that policy makers made the great mistake of listening to the ‘deficit hawks’. According to Krugman, the 2009 stimulus was too small.
“Those who had more or less the right ideas about what the economy needed, including President Obama, were timid, never willing either to acknowledge just how much action was required or to admit later on that what they did in the first round was inadequate.” Instead of treating the dismal jobs picture as a crisis requiring their full attention, Washington “pivoted” to talking about the deficit – a phantom menace — at precisely the wrong time. “People with the wrong ideas,” Krugman writes, “were vehement and untroubled by self-doubt.”
Later, even talks of stimulus dropped off the radar, as the narrative turned to austerity and deficit reduction. Krugman argues the premature fiscal consolidation was unnecessary and harmful.
Krugman argues the ‘deficit hawks’ including a lot of respected orthodox economists made serious mistakes.
- In a liquidity trap – with rapidly rising saving rates and fall in private investment, higher government borrowing does not push up interest rates. In other words, government can borrow more in times of a recession.
- Pursuing ‘austerity’ measures does not improve confidence. As Krugman terms it the ‘Confidence Fairy‘. In fact pursuing spending cuts undermined consumer confidence and led to a deterioration in spending and investment.
- Austerity can be self-defeating. By cutting government spending, output falls leading to further falls in tax revenue and more difficulties in reducing the deficit.
His arguments mainly centre on the US, though they apply equally to the UK and EU.
What Does Krugman Propose?
- It doesn’t have to be like this. We don’t have to tolerate unemployment of 8% (or 20% in parts of the EU) We can pursue strategies for growth and lower unemployment, now.
- Making economic growth a priority and willingness to tolerate a higher inflation rate if necessary.
- Higher short-term government debt, so that government investment can provide an economic stimulus.
Krugman writes in a very direct style. He isn’t hesitant to attack orthodoxies and he unsurprisingly creates a polarity of opinion. He argues his critics are unwilling to admit they are wrong and remain untroubled by self-doubt. However, you could say the same about Krugman, he seems to have no self-doubt, but great belief in his view. However, overall, he has a good track record in making predictions.
- He predicted higher debt wouldn’t lead to higher interest rates
- He predicted expanding monetary base in liquidity trap wouldn’t cause inflation.
- He predicted austerity measures pursued by European countries would lead to lower growth and a bigger contraction.
Also, I like how he has been able to change the narrative and exposing the belief of the American right, that they can cut the deficit when they only thing they propose is tax cuts (mainly for the better off). From a UK perspective, I believe the UK made a serious mistake in pushing austerity measures at the wrong time. The Coalitions great plans to cut spending pushed the economy into an unnecessary double dip recession. I hope Cameron and Clegg find time to read.