Monday, June 28, 2010

Depression Coming - Paul Krugman Plays Economist Again.

I just came across this post from tech ticker in which Krugman claims we're heading for another great depression. His reasoning? The governments of the world haven't yet bankrupted themselves sufficiently.

Yes, it seems that unending bailouts and unchecked handouts like the ones that got Greece in the news just don't go far enough.

Krugman contends that our economy is poised to re-run the events of 1937:
"Krugman believes that this is exactly the same mistake we made in 1937, when the country was beginning to emerge from the Great Depression. A sudden focus on austerity in 1937, it is widely believed, halted four years of strong growth and plunged the country back into recession, sending the unemployment rate soaring again."

The problem I see with this is that we haven't had 4 years of strong growth - in fact we've had less than a year of questionable growth (the government keeps revising the GDP downward)!

Another problem I have with this reasoning is that the Great Depression was a confluence of many different factors, and to imply that the government not saddling its citizenry with "enough" debt was the cause is just simplicity of the most naive sort.

But perhaps the biggest reason I discount Krugman's economic theories is that he is more political hack than economist. I don't expect him to not have a political preference, and I'm actually glad that he lets people know where on the political spectrum his views lie. But all to often his economic work is little more than a thinly veiled political attack at those on the opposite side, and that just detracts from the science of economics.

What say you? Am I off base here, or is Krugman little more than a hack?


Michael Harr @ TodayForward said...

If consumers aren't spending and a deleveraging cycle is underway, who will start spending to grow the economy? If you don't want the government to spend, then who will? This is the central idea that Krugman is trying to get across. When aggregate demand falls off a cliff, the government is the only entity that can come close to injecting the kind of spending needed to get the economy moving again.

While the long-term problems of deficits and mounting debt are very real, they are exacerbated by a weak or shrinking economy. This is a classic case of "damned if you do, damned if you don't." If we spend too much money now, we will get an economic rebound but will have debt problems to tackle later. If we don't spend money, we will drop back into recession and have lower tax collections later.

From Krugman and neo-classical Keynesians' perspective, 'G' needs to be spending big right now. From the Austrian school, austerity is needed and we'll just have to take our medicine now to avoid total collapse later.

Regardless of politics, the bottom line is that if the government stimulus isn't effective, we will drop back into recession and risk looking an awful lot like a depression. U6 unemployment figures are already close to those seen in the Great Depression, so it's not like we're really all that far away from Krugman's prediction.

From my perspective, we need more spending as stimulus, AND we must also cut entitlement programs over the long run. This accomplishes what everyone wants - (1) get back to solid growth, (2) show fiscal restraint over the long run.

Of course, cutting entitlements is political suicide so we're left arguing over stimulus spending.

Mike said...

First, let me say thank you for a very thoughtful comment Michael.

I see where you're coming from, but I think that the Keynesian model is an illusion. Government spending does not create true growth, only temporary lessening of contraction at the expense of the future. Government stimulus can only postpone collapse and usually leads to bigger problems down the road. I think that some of the stimulus spending, particularly TARP, helped to prevent a complete breakdown but that's far from creating growth. Furthermore, every bit of stimulus since has had less and less effect, as seen by the constant revising of GDP growth downward. If we factor out government spending then we're left with a stagnant economy at best. That's no recovery in my book.

Michael Harr @ TodayForward said...

@Mike - Thanks for the reply, and I'd like to point out a few things that are missing from this discussion and others like it that are happening around the country.

All economic models are flawed. This is by definition as a model seeks to build understanding by simplifying large, complex piles of data and boiling it down into something easier to wrap our brains around. Until complexity economics and its tools (data collection and computational analyses) bear more fruit, we're stuck with these models.

While government spending isn't 'organic', it is a necessity at times. TARP was an absolute necessity. The stimulus was a choice. The options were (1) let the market correct itself while inflicting a tremendous amount of pain or (2) spend enough money to stabilize the economy until consumers can bring us back to growth. As you point out, the stimulus has had far less impact than expected.

This brings us back to Krugman. From the beginning, he railed that the stimulus was too small. As it turns out, and as you point out, he was right.

Last note. Be careful not to discount stimulus money and the fact that we're treading water. This is still a very big accomplishment relative to the level of problems we have in the housing and financial sectors. If you take a deeper dive into economics, you'll see that government spending (while not returning us to healthy growth figures) is keeping more people employed and reducing the number of discouraged workers that exit the labor market - permanently.

The costs associated with a bona fide depression are astounding. Given the choice between fiscal restraint and fiscal stimulus when the economy is in the tank, I'll take stimulus every time. There is a time for austerity, but it certainly isn't now.

By the way, I'm a fiscal conservative, so Krugman rubs me the wrong way at times, but it's very clear to me that a shutdown in government spending will be a disaster. If things aren't good with government spending, how much worse would they be without it?

Nice post and a fun topic to debate.

Gene said...

Not being an economist, I may either see things more clearly or less so, depending on your bias. However, I would sum up the argument for the effectiveness of adequate stimulus with one brief observation. It's no accident that World War II, the greatest government stimulus program ever, ended the Great Depression.

I would also comment on the credibility of Paul Krugman that he was one of the only people consistently warning of a serious problem in the housing market years before the problem occurred. I read many columns in which he warned of a coming serious problem, though he didn't anticipate that it would be as serious as it turned out to be. I hope Paul Krugman is overstating the case for a depression but I am quite pessimistic. And it should be noted that he is not ssaying a 1930's depression is coming. He is talking about an extended period of negative or slow growth such as Japan experienced in the nineties or such as America experienced following the panic of I believe the date is 1871. Whatever the case, the media coverage of Mr. Krugman continues to distort his comments by implying or stating that he is predicting a 1930's style depression or by not explaining what he is saying, thus misrepresenting his comments and causing him to seem like an alarmist rather than a reasoned analyst.

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