So I spent the past few days reading and reviewing Paul Krugman's latest book, End This Depression Now!, as part of my project of reading only the contrary side for a year. It was on my "to-read" list anyway, so I figured I'd just bump it to the top of the list.
Anyway, here is Krugman's case in a nutshell. He argues that all the typical concerns you might have about massive government deficits don't apply when the economy is in a liquidity trap. (I really wish he would take care to note that he defines liquidity trap very differently from the way Keynes defined it, but let's not ask for the moon.) Because the Fed has pushed interest rates to near-zero, it can't do any more to stimulate the economy. And because private spending and investment are below a level that sustain full employment, the federal government can borrow and spend without crowding out private spending or creating inflation. Deficits and the national debt do matter, but not right now. We can - and should - worry about those issues once the economy is humming along again. And doing that doesn't even require massive debt payments. After World War II, the debt wasn't exactly paid off - it was kept level and as the economy grew the debt to GDP ratio correspondingly shrank. Because the federal government can borrow at very low rates, an additional $5 trillion in borrowing would cost about $125 billion a year in interest payments to sustain. Once we are restored to full employment, the deficit will shrink automatically, because tax revenue will rise and less will be paid out in unemployment benefits and the like, and the national debt can be both grown away and inflated away. Some mild inflation would be beneficial, because it makes workers cheaper to hire, as well as relieving the burden of private and national debt.
So, what did I learn from this book? Honestly, not much, because if you've read any of Krugman's previous work, you've already read most of this book as well. (I think this is his third book telling the story of the babysitting co-op...) I'm pretty sure Krugman would agree with this characterization, because his recurrent theme throughout the book is that the answers to our problems are already well known and have been known all along, but aren't being used.
Credit where it's due: Krugman has a knack for clearly explaining Keynesian economics. He's not nearly as skilled at explaining the views of his critics, though - or if he is, he's keeping those skills a secret. A quick rule of thumb - when you explain your views in terms of reason, and explain all contrary views by means of psychological analysis, you're probably being unreasonable. To Krugman, possible reasons for not agreeing with him consist of: ignorance, blind commitment to ideology, and moral insanity. That's about it. And the list of people he's willing to pin those charges to is quite substantial - including Nobel laureates in economics and leading academic economists like "Harvard's N. Gregory Mankiw and Columbia's Glenn Hubbard," both of whom, Krugman also mentions, are "quite Keynesian in their views of macroeconomics." Faced with the specter of mainstream Keynesian economists who disagree with him, Krugman faces three options. Option A: he might concede that this is a complicated issue and reasonable, intelligent and honest people can disagree. Option B: he might consider the possibility that he just hasn't presented a persuasive case for his views. Option C: he can hand-wave away all disagreement by endorsing claims like "Bernanke was assimilated by the Fed Borg" and "the pressures of groupthink and the lure of camaraderie" are the "real" reasons why Bernanke (and others) disagree with him. As elsewhere in life, the answer is always C.
Many people have worried that an activist government can create uncertainty in the business world and by that fact hamper economic activity. If the rules of the game are constantly changing, and you can't predict in what way they will change, you'll naturally be less likely to want to join in. Krugman has been a loud voice lately dismissing what he calls "the confidence fairy," and he's equally dismissive of the possibility of government-created uncertainty in this book. Hence, Krugman writes that government should "just reduce [homeowner] debt directly. Debt, after all, isn't a physical object - it's a contract, something written on paper and enforced by government. So why not rewrite the contract?" He attempts to equate this with Chapter 11 bankruptcy, but that's an unconvincing comparison. The rules and procedures of bankruptcy court are known in advance to those who enter a contract. That in no way compares to what Krugman is proposing. Part of the advantage of the "rule of law" is that it gives people the ability to know in advance what to expect and what is expected of them. Creating special ad hoc exceptions to these rules undermines that confidence, and hangs a big question mark over the validity of future contracts.
Incidentally, I discovered a new believer in the "confidence fairy" this morning. I was reading the first few chapters of Mark Zandi's new book Paying the Price: Ending the Great Recession and Beginning a New America. The book was written to argue that the bailouts and the stimulus worked. In the introduction, Zandi makes the following observations, which deserve to be quoted at length:
Perhaps the most serious downside to Dodd-Frank was the uncertainty it created. Already stressed, the financial system was forced to make complex changes quickly, amid a blizzard of other regulatory and legal issues. Nervous and confused, bankers didn't know how much capital they would need, nor the cost of that capital, and were unsure of their legal liabilities and regulatory costs. Bankers hunkered down in response, lending sparsely and conservatively. Dodd-Frank intended to ensure that credit would flow less recklessly than it did during the hosing bubble; but the law's effect, at least at first, was to slow credit from flowing freely enough.I wonder if Krugman would consider Zandi just another crank speaking nonsense about the confidence fairy...
While the financial system was grappling with Dodd-Frank, non-financial businesses were growing anxious about other big changes emanating from Washington. In early 2010, the Obama administration passed a massive overhaul of the healthcare system. It's main intent was to provide health insurance to the millions of uninsured Americans. But although many of the law's provisions wouldn't come into effect for years, small businesses struggled to understand what it meant for them. New environmental and labor regulations, and tougher enforcement of those already on the books, also contributed to business angst. In normal times all this might have been seen as just a cost of doing business, not a major problem - but these weren't normal times. Skittish businessmen grew more cautious, slowing down investment and hiring.
People were also unnerved by the government's ballooning budget deficits. The nation's debt, as a proportion of GDP, doubled in only 5 years to it's highest point since just after World War II. The federal government had significant fiscal problems even before the Great Recession; now tax revenues plunged with falling employment and corporate profits, and government spending surged with the unemployment rate. The tab for the government's efforts to save the economy from calamity came on top of all that. To bail out Wall Street, the auto industry and housing, provide enough capital to keep Fannie and Freddie afloat, and then launch successive fiscal stimulus efforts, cost $1.8 trillion - more than the wars in Iraq and Afghanistan combined.
Anyway, back on track.
Krugman's chapter on Europe was a bit of a head-scratcher for me. On the one hand, he very effectively describes why the euro was a terrible idea. He notes that "European elites were so enthralled with the idea of creating a powerful symbol of unity that they played up the gains from a single currency and brushed aside the warnings of a significant downside." Pontificating about high sounding ideas, however vaguely defined, does have a long history of trumping sound economic reasoning, and Krugman is very effective about calling them out on that. But as the chapter comes to a close, he notes "the euroskeptics, who warned that Europe wasn't really suited for a single currency, were right. Furthermore, those countries that chose not to adopt the euro - Britain, Sweden - are having a much easier time than their euro-using neighbors." But he opposes dropping the euro on the grounds that "an about face on the euro would be a dramatic political defeat for the broader European project of unity". Ugh.
Krugman is in top form with his chapter on inflation, though. I was skeptical of claims that runaway inflation was "just around the corner" when those claims started blowing up my Facebook page, and the blogosphere, five years ago. Those claims didn't even have a convincing theoretical foundation back then, and certainly haven't been vindicated by experience over the past several years. +1 for Krugman on this issue.
Predictably, Krugman commits one of my pet peeves when discussing banking regulations. He argues that banking regulations were sorely needed because of how common bank failures and bank panics were prior to the creation of the Fed. To prevent bank runs, we need deposit insurance. Of course, deposit insurance creates moral hazard problems, because why be cautious when your deposits are insured? So we need more regulations to deal with moral hazard, etc. But here's the thing - Krugman makes it sound as though banking was totally unregulated before this, and it wasn't. One very nasty bit of regulation before the creation of the Fed was unit banking - once you opened a bank, you were extremely limited, if not outright prohibited, from opening banks in any other area. Imagine if I created an investing regulation that said people could only invest in one stock - there would not be any diversified stock portfolios. You could invest in Krispy Kreme, but if you do, that's it - you must put all your eggs in that basket. Upon seeing that the stock market isn't doing so well, further imagine if I said this shows "unregulated investing" is inherently flawed, and that we needed to create a system that insured against bad investments, to prevent stock panics. And because people are insured against losses, we need to further regulate the way they invest in stocks to make sure they do it "responsibly." What nonsense that would be...
Throughout the book, Krugman doesn't really do much to address opposing arguments. He does briefly acknowledge that some exist, but he never really confronts them substantially. He usually spends about three sentences presenting a watered down version of them, and then masterfully "refutes" the argument as he himself has crafted it. As a result, I didn't find this book much of a challenge, and I don't expect any convicted opponents of his arguments will feel a direct challenge either. It's a good book for preaching to the choir, but it's not going to impress those not already converted.
The book does raise one puzzle for me. Krugman dedicates the book to "the unemployed." He spends a good portion of the beginning of the book describing the various negative effects of being unemployed - the loss of self respect and morale, the social stigma, the damage to future employability. And he's right, those are all terrible things.
In his book Pop Internationalism, Krugman says of Europe that "the taxes and regulations imposed by Europe's elaborate welfare states have made employers reluctant to create new jobs, while the relatively generous level of unemployment benefits has made workers unwilling to accept the kinds of low-wage jobs that help keep unemployment relatively low in the United States." As a result, the level of unemployment in Europe chronically higher than the US. Recession level unemployment in the US is average unemployment in the EU.
But Krugman has also been a loud advocate of European style "social democracy" and of the US having a welfare system and social safety net more like Europe's. Don't the indignity and degrading effects of chronic unemployment constitute a powerful argument against a European style welfare state, if such a state of affairs creates that level of unemployment, as Krugman says it does? I am puzzled.
Most unintentionally funny line in the book: "This is a book about what to do now, not about placing blame for what was done wrong in the past."
My favorite passage of the book is where Krugman talked about how free trade also promotes peace as well as economic efficiency.
The experiment began in 1951, with the creation of the European Coal and Steel Community. Don't let the prosaic name fool you: this was a highly idealistic attempt to make war within Europe impossible. By establishing free trade in, well, coal and steel - that is, by eliminating all tariffs and all restrictions on cross-border economic shipments, so that steel mills could buy coal from the closest producer, even if it was on the other side of the boarder - the pact produced economic gains. But it also ensured that French steel mills relied on German coal and vice versa, so that any future hostilities between the nations would be extremely disruptive and, it was hoped, unthinkable.