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Source link: http://archive.mises.org/12997/i-challenge-krugman-on-austerity-and-spending/

I challenge Krugman on “Austerity” and Spending

June 17, 2010 by

In this Krugman-in-Wonderland post, I challenge Paul Krugman on his view that the only thing that can end this downturn is government spending, funded by borrowing and printing money. I’m always amazed at the economic ignorance that these people give us, but there it is.

{ 27 comments }

bobobberson June 17, 2010 at 2:10 pm

Its like if I jumped off a cliff, and hit the ground and really hurt myself, Krugman would argue that I didn’t hit the ground fast enough. I should have jumped from a higher cliff and then it wouldn’t hurt. Its foolish to assume that jumping from higher up would yield a less-painful result. Especially when one looks at history and sees that more of the same results in much worse pain. The laws of Economics are like the laws of Gravity.

A person has to balance a budget, a family has to do the same, a business likewise, a city has to also, a county has to balance their budget also, in addition a state has to balance a budget. So why does the national government NOT have to balance their books?

Shay June 18, 2010 at 10:48 am

The golden rule: he who has the gold (or at least gold-plated tungsten) makes the rules.

MBCOA August 25, 2010 at 2:29 pm

This “families need to balance the budget therefore government should” is a specious argument. Governmets, like individuals and companies, have to stay solvent. That doesn’t mean only spend what they have. All responsible people and companies borrow. When the risk-adjusted returns on investments made with borrowed money exceed the cost of borrowing (interest), that’s called a good investment. If my business can borrow $100mm at 5%, and earn $10mm a year on the factory I build with that money, that’s a good use of funds. As long as I have $5mm of cash flow available to cover my interest costs, my “budget is balanced”.

DX June 17, 2010 at 2:34 pm

Krugman would and does say that nations are not subject to the necessity to balance budgets because they can print currency, which is cool because more currency means more purchasing power, which means more aggregate demand, which means more GDP. I have not, however, heard an explanation of what will happen when those hoarding the stimulus cash (banks) start using it. “Look, we’re printing and there’s no inflation!” “Well, see what happens when I un-kink the hose.”

Jonathan Finegold Catalán June 17, 2010 at 3:24 pm

How does more currency equal more purchasing power?

Matthew Swaringen June 18, 2010 at 6:32 am

It doesn’t equal more purchasing power in the long run, but it does mean more purchasing power in the short run for those who get it first before prices are bid up.

Then the “foolish” savers money becomes worth substantially less, and the effects are felt by everyone who didn’t get the cheap credit in higher prices for goods that are in reality actually limited and not produced simply because people have more money to spend.

Barry bell June 18, 2010 at 8:15 am

he was being facetious . I think anyway.

DX June 18, 2010 at 9:43 am

I was. I’m just following Krugman’s oft-expressed train of thought. It’s a little ironic that the hoarding so supposedly dangerous to the whole economic recovery is being directly funded by the government on a scale that would have been utterly unachievable on an individual basis. Normal folks would spend some and save a little as appropriate, but you give BANKS trillions and oh, baby, oh… watch the magic.

J. Murray June 17, 2010 at 3:07 pm

All you need to do is take the wind out of this guy’s sails is ask one simple question: at what point in history did this sort of thing actually work or are we just taking Mr. Keynes hypothesis at face value without bothering to test to see if it works?

michael June 18, 2010 at 8:10 am

A good question, Mr Murray. That would be during WW Two, where we utilized massive deficit spending to end the Depression, provide full employment and win the war against Hitler.

It worked like a charm. Since then no one’s had the courage to apply both sides of the lesson, which are:

1) Spend whatever it takes to get the country working again, and
2) Retire the resulting debt in short order.

I would invite you to take a look at the size of the federal debt over the 1940s. As you’ll be able to see, we were able to bring it under control in an admirable period of time.

Bala June 18, 2010 at 8:16 am

You forgot to add

3) Start a war every time the economy is in trouble

Daniel Hewitt June 18, 2010 at 8:29 am

Indeed. Reaching “full employment” by sticking people into foxholes in Europe is probably not a good strategy to repeat. The economic recovery began once the War ended and the government spending was reduced.

michael June 19, 2010 at 7:50 am

Bala– This is a key point, and well worth raising as so many politicians believe that.

What raises personal incomes, employment and industrial production is the mere addition of more money into the economy. It need not be spent on instruments of war.

In fact it’s less efficient when you do it that way. In wartime, America was fully employed but peacetime production had been replaced by weapons production. So no one had anything they could buy. All saved their incomes until after the war, when a spending binge ensued.

But all those weapons added nothing to the economy. They were either just destroyed or declared surplus, and few were ever resold. Were we to manufacture consumer items instead, they’d be resold and more taxes would come back to Washington, to retire the debt. A perpetual war economy, such as the one we have now, makes the mistake of always having to stimulate unproductive production by adding more and more fiat money at the front end of the furnace, stoking the heat. We would all agree that’s a mistake.

If instead you shut down the engines of war and transition to a full peacetime economy, your industrial output appears in stores and is bought. Once employment grows to acceptable levels you stop adding fresh debt and start paying it down through tax collections. Of course the rates must be kept at a healthy level, including those on corporate profit and unearned income.

That’s the way we did it in the late 1940s. Look at the numbers on how the wartime debt went down. Taxes were high, people were spending like crazy and America entered a period when consumer confidence was highest– the 1950s.

I would want to transition from what we have now into a permanent peacetime economy, so all our increased production went to create material wealth, not instruments of death. For one thing such a move would result in more taxable sales, and fewer total losses of costly industrial product (costly both in terms of labor and materials).

Bala June 19, 2010 at 7:56 pm

” What raises personal incomes, employment and industrial production is the mere addition of more money into the economy. ”

If only this were to be the only effect. Unfortunately (for your fanciful theory), addition of more money through a system of fractional reserve banking and doing so through credit expansion causes the Business Cycle. This is Austrian Business Cycle Theory. Friedrich Hayek won the Nobel Prize in Economics way back in 1974 for this theory. Austrian economists have been using this framework to predict depressions ever since Mises predicted the Great Depression in the 1920′s.

Read up ABCT. It will then be possible for us to have a genuine discussion.

michael June 21, 2010 at 3:41 pm

Thank you for a civil, nonsarcastic response.

When I said ” What raises personal incomes, employment and industrial production is the mere addition of more money into the economy. ” I should have been more specific, and reminded you that we were discussing times when monetary stimulus was being implemented. You said that war was responsible for the full employment in 1942-45, and I said no, it was merely the addition of more money.

Please keep that in mind. What I was NOT saying was that always and on every occasion, we can create more prosperity just by printing more money. I know it may seem that way to you, but try following my train of thought more closely.

Your Austrian Business Cycle Theory is just that: a theory. And it does not fit the instance of our later 1940s, if you’re saying the implications are that a monetary stimulus was harmful. What happened was, we incurred debt. And the good incomes that resulted from this debt creation resulted in more consumer demand. And that resulted in more jobs being created AFTER the war, to replace the jobs lost when the soldiers came home. So instead of returning to a place where there was no money and no work, GIs came to a new America, where there was not only opportunity to earn good money, but the GI Bill.

It was possible to have a college education without being rich. It was possible to buy a brand new house and not just rent an apartment. And it was possible to have enough money left over after all that, to pay taxes sufficient to retire the debt the government incurred at the outbreak of war.

Stimulus works. I could read 300 pages of how it can’t possibly ever work. But I lived through that era. Deficit spending, when needed, works just fine. (And in fact the entire capitalist system is based on credit and lending.) All one has to do is to be responsible, and in the end pay off one’s debt.

Beefcake the Mighty June 21, 2010 at 3:59 pm

“What happened was, we incurred debt. And the good incomes that resulted from this debt creation resulted in more consumer demand. ”

LOL, and you know these incomes were “good” because…how, exactly? What a moron. You sound like an aging hippie telling us about the glories of Woodstock.

Magnus June 18, 2010 at 6:13 pm

Wow. There’s not a single tidbit of economic stupidity and statist propaganda that michael hasn’t swallowed without question, is there?

Please try to do just a little homework before you spontaneously embarrass yourself yet again.

Here’s a book for you to read: http://mises.org/store/Depression-War-and-Cold-War-P334.aspx

Here’s an article you can get for free: http://www.independent.org/publications/tir/article.asp?a=656

And here’s an audio recording, if you have trouble with the whole “reading” thing: http://mises.org/media/1425

michael June 19, 2010 at 8:11 am

Thanks for the patronizing air, Magnus. I don’t have much trouble with the ‘reading’ thing (in fact I would suspect I had read a great deal more widely as well as more critically than you), and will look at the items you’ve set before me.

As for the Independent Institute piece, every economist of any note agrees that WW II got us out of the Depression. Any other interpretation would have to rely on a truly marvelous degree of coincidence. How would one explain, for example, the link between the need for wartime production, the appearance of sudden full employment and the growth in people’s savings accounts? I would suspect the motives behind any revisionist theories that flout the obvious observations, that wartime production put money into people’s pockets that later was spent to everyone’s great benefit.

But I’ll look at what your guy has to say.

Before tapping into the other piece, an entire book you’ve set before me, I’ll want to find a space in my current reading list. So I’ll only offer this: the United States is still in a full-time war production mode, and has been since 1942. When the Soviet Union fell some of us tried our best to transition to that ‘peacetime dividend’. But by then, entrenched interests in permanent war could not be dislodged. And in fact since 1991 war spending has gone up, not down. And the permanent state of war, the ‘war without end’, has become fully entrenched in the thinking of both parties. War policies haven’t changed a whit between Bush and Obama, for instance.

There are any number of reasons to oppose senseless aggression against impoverished nations with no capability to retaliate, but I’ll limit myself to the subject under discussion: is this good for business?

Both I and M. Keynes would say NO. Deficit spending to bring up employment and production is a useful tool only to the degree that it is limited in scope and duration. Let it become a permanent fact and it will in time become fatal to the fortunes of both the United States and to the dollar.

And once again, money supply expansion and deficit spending, to feed our addiction to military spending programs, have been our policy, except for brief periods. since 1942. We need to stimulate the economy only when it lags– and lay off the cocaine once it’s up and running. Give it the juice on a continual basis and at some point it keels over, as Marx once said, from its own internal contradictions.

David June 19, 2010 at 8:19 am

“As for the Independent Institute piece, every economist of any note agrees that WW II got us out of the Depression. ”

So every economist of note is a moron. Destroying things has NEVER created economic success. That’s taking the broken window fallacy to a whole new level. If war was great for the economy, then Africa would be the wealthiest continent on Earth.

WWII did not pull America out of the Depression. It was fully in Depression in 1945-46. The massive decrease in government spending from 1946-47, something every economist of note predicted would result in disaster, brought America out of Depression.

Again that whole thing about economists and weather predictions.

MOHS_01 June 19, 2010 at 9:25 pm

Michael,

I believed you wiser and better informed prior to reading this thread. Surely you do not believe the myth of wartime prosperity….

The problem that I have with current mainstream macro is that it deals predominantly with aggregates, which often have a life of their own…. and one that does not reflect the “real” economy of households or private enterprise. It is much like my colleagues who treat, manage, and massage lab values rather than looking at the patient and seeing how they’re actually doing in daily living activities.

MOHS_01 June 19, 2010 at 9:38 pm

Michael – “How would one explain, for example, the link between the need for wartime production, the appearance of sudden full employment and the growth in people’s savings accounts?”

That’s not all that difficult to account for, my friend. Starting with the “sudden, full employment” — you do realize that, at one point or another during the war, almost 1/3 of our prime workforce was conscripted, right? If you have 20% unemployment and remove 15% of the workforce populace for war duties, unemployment will drop rather dramatically. Moving on to the savings…. I am sure that you realize that, in the beginning of the Great Depression, there was an implosion in the money supply, with a great many people losing whatever money they had in banks. Couple this with the near halving of wealth that resulted from the confiscation of gold and revaluation of the dollar and the persistently high unemployment levels… and you have created a populace of savers. So we start out with a time where there was little money available for the purchase of goods, uncertainty about the future availability of income, etc — only to follow with the war time “full employment”. Oh wait, there’s a catch: that pesky little institution of rationing. So…. during the depression there was not much money to buy things…. and during the war there was nothing that you were allowed to buy. Savings goes up.

Josh June 17, 2010 at 3:30 pm

J. Murray:

You are forgetting the fact that 9/11 changed everything. ;)

Mark F. June 17, 2010 at 10:00 pm

Well, governments always have to balance their books eventually. By taxing or inflating (a hidden tax), or by stiffing its creditors. No free lunch, you know. Everything must be paid for.

mikey June 18, 2010 at 1:49 pm

“I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretence of taking care of them.” –CIGA Eric.

This simple sentence which was posted yesterday at mineset contains more wisdom than Krugman’s lifetime of irresponsible babbling.

tungsten watches July 23, 2010 at 3:24 am
David Ruggles July 29, 2010 at 11:40 am

I’m trying to find where Krugman says, “The only thing that can end this downturn is government spending, funded by borrowing and printing money.” I hear him say that government should provide stimulus to prevent the economy from falling into depression. This until other fundamentals like consumer confidence, repair of the financial system, restructuring of the industrial sector, etc., etc., have time to gain traction. It’s easier and quicker to crawl out of a ditch than a canyon. Without consumer demand, not much is going to happen. I lived through the Reagan era as an auto dealer. I can assure you things didn’t come back over night, despite the massive tax cuts and deficits.

David Ruggles July 29, 2010 at 2:24 pm

As I read posts on this site it appears it is more about “piling on” than intellectual exchange. I should have realized that from the page heading.

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