Regular readers will know that I have a track record of bashing arch-Keynesian provocateur Paul Krugman. But my views on Krugman — as well as Keynesian thought in general — are complex. For a start, I think his work on economic geography is excellent, and I rather wish he could take it to the same logical conclusions that I do.
In a way, he reminds me of Karl Marx. Marx’s exhaustive studies of 19th century capitalism are fascinating and essential reading. But Marx’s proposals for the global economy were ineffectual, just as Krugman’s solution to today’s economic malaise — throwing more money at the problem — is quite superficial. Plus, as a polemicist, he has been guilty of some raging hyperbole. But so have I.
Now, admitting that austerity is a problem has been quite difficult for me. Most of my political impulses are libertarian, and I see the accumulation of state power and an expansive state role in the economy as deeply problematic, mostly due to the problem of capital misallocation. But is a time of severe economic recession and weakened confidence really the appropriate time to cut spending, and throw welfare recipients – many of whom are elderly or disabled — into the blender? I’d love to see less state involvement in the economy, and I think there are a good deal of wasteful programs — e.g. overseas military adventurism — that can be cut right now in the name of paying down debt and improving infrastructure.
But the time to really cut is when the economy has significantly rebounded: when the private sector is creating jobs, when confidence is higher, when tax revenues have rebounded.
Krugman’s criticisms of Cameron have been rather different to mine: his line has been that cutting spending in a demand-depressed economy will just lead to lower demand. I take a slightly more qualified line.
The real problem here is that cuts in today’s environment are contractionary. That’s because of the debt. A high debt load means that service cuts are not offset with tax cuts. The money saved just goes toward balancing the budget, and not back out into the real economy where it can be used to create jobs and growth. The correct time for Cameron’s policies was during the last boom — when the economy is naturally at high steam, and is creating lots of jobs and growth. The best future period for these policies will be the next boom. Now, the argument Cameron might use is that there won’t be a “next boom” unless we take drastic action to reduce debt. Britain already has a huge total-debt-to-GDP ratio; we can ill afford another credit-financed boom. But austerity doesn’t even seem to be much use at reducing deficits: in a depressed economy, as government-spending falls tax revenue also seems to fall.
Today Krugman obliterates the austerity policies of David Cameron’s coalition government:
Back in June 2010, when George Osborne unveiled the Cameron government’s austerity plan, it was all about confidence.
So how’s it going?
The Cameron government likes to point to low British interest rates — which are not just the result of safe-haven flight into the bonds of every advanced-country government that still has its own currency. Except, actually they are:
Still, the government’s commitment to fiscal responsibility has led to rising consumer confidence. Or, actually, not:
Business confidence! That’s the ticket! Or, well, no:
Will Osborne and Cameron listen to the raw empirical data that suggests very strongly that their policies are not working? Or will they drive onward on the strength of their ideological fervour?
But if we don’t cut the debt levels, won’t it be very, very difficult to get back to growth and private sector job creation?
Yes but austerity is contractionary, so tends to actually lead to falling tax revenues, and thus bigger deficits.
The real problem is that a debt-based system’s stability is necessarily based on credit expansion.
Of course, slowly inflating our way out isn’t possible either. The system is fundamentally broken, and in the end bondholders will either have to take haircuts, either directly or via crushing inflation.
You are correct that in the end bondholders (which are all of us) are going to take haircuts. Those haircuts would have been smaller had this all been allowed to unwind and implode in 2008. Each year that passes the future haircuts become worse and fall to more (younger) people.
I understand the conundrum you feel wrt Keynesianism. It’s not that Keynesianism is wrong so much as it can’t work. In the US we see this via the Bush Tax Cuts. Going into the Bush presidency we had a budget surplus and were forecasting surpluses for as far as the eye could see. Keynesianism says that in times of growth the government should take on surpluses so that in the inevitable contraction, the government can spend its surplus to get through to the next period of growth. Politics doesn’t allow for this in practice, however. That surplus was the government taking more of our money than it needed and it should be given back to the taxpayers. So went the Bush campaign line. While the idea that Keynes put forward would work, no politician and, by extension, no population will enact it.
At this point we have the government spending from deficit and not surplus… this is not working. While contractionary austerity policies may be, indeed, contractionary. The stimulus deficit spending is not actually expansionary. There is no choice but a massive, painful reset. The only question now is whether the Boomers will be able to kick the can long enough so that they can kick the bucket before it collapses.
This is a perfect analysis of the problems with the Keynesian approach to the business cycle. Of course, Keynesianism does have many problems with its predictive technologies, too, which is the area I personally start to have big problems with Keynesianism.
Extremely unlikely. I give Dr. Paul a lot of credit for his analysis of this in the 1980s and 1990s. That was prescient. Now it is plain and obvious for everyone to see (unless they choose to be blind). The reset will surely be before 2020 and possibly as early as this year. I would be shocked if it weren’t.
Keynes stole his idea of governments saving the surplus in goodtimes and redistrubuting the saved surplus in downturns to smooth the business cycle.
The idea of the goverment saving its surplus comes from the Old Testement (I believe the book of GEN., but I am lazy and don’t want to look it up.)
The cliff notes for the Old Testement Keynesian go like this. The Pharoh has a couple of bad dreams and comes to find out that Joseph (chilling in jail at the time) can interpret dreams. Joseph comes to tell the Pharoh that his dreams forecast “seven years of plenty followed by seven years of famine.”
Joseph’s solution? Saving 1/5 of the harvest during the seven years of plenty. The plan went so well, that it is said that Joseph was able to feed other countries that were suffering from famine as well.
You see, even the “godfather” of modern economics was an intellectual thief.
The history of human thought is a history of intellectual magpies.
my point exactly…. austerity may be painful, but that is the only solution.
Of course not pure-austerity, but one combined with gov. shrinkage.
What most ppl forget is that austerity+gov-shrinkage means LOWER prices which means easier to cross the gap.
I don’t understand this urge from economists to “manage” everything.
Why can’t they finally accept that economics is not physics and that millions of ppl corroborating via the price mechanism and trade are more probable to find a solution than their wishful thinking in their ivory towers.
I don’t either, but once you have created a managerial system it is quite problematic to suddenly switch over to freedom. We need to try and make the transition out of government dependency as painless as possible. A painful transition via austerity during a depression will give the statists more rhetorical ammunition.
Isn’t it the case that there haven’t been any net cuts yet in the UK? I thought that all we were doing so far was reducing the rate that the deficit is expanding. Actually reducing the deficit is still some years in the future, and as for reducing the underlying debt, I don’t think anybody is even talking about that yet.
Still, let’s assume that Krugman is correct and Cameron is cutting. I’ll agree with you that raising taxes, and cutting spending is going to make things worse, but surely after a few very tough years, fiscal discipline will bring about the conditions for renewed growth. However, continuing to throw new debt at the problem, whilst providing a short term sugar rush, simply makes the situation worse further down the road.
Furthermore, the way that bail outs and QE are undertaken has little if anything to do with efficient allocation of capital, productive job creation, or firing up entrepreneurial spirits. If this were the case, maybe your tacit support for less austerity might be reasonable, but instead the money is used to bail out banks who recycle it back to their central bank, or wasted on green projects, high speed rail links, or any of the other thousand ways that bureaucrats waste our money.
From one libertarian inclined individual to another, I’m afraid whatever we do is going to lead to a depression so rather than worrying too much about what is the right thing to do, because the government is never going to do the right thing anyway, I tend to worry more about how to minimise the impact of what is to unfold on myself and my family.
Well, I am starting to think that the so called “Nuts” (Survivalists etc) were right.
Buy arable land, far away from major population centres. Keep a store of non perishable food. If you are an American (possibly weapons to protect yourself.
At least you die free right?
At least if the world does not implode, you have a weekender, and can always go hunting for fun or just target practice. Hey even sell your guns back to the Government like they did in Australia.
Yes, in terms of total spending, Cameron is cutting proposed increases. But many department budgets are being cut in real terms. A lot of it is geared toward pushing welfare recipients back into work… But the jobs just don’t exist.
How? Both of these policies will just tend to lead to decreasing tax revenues, so government debt will most likely still rise.
I’d look at it like this: government is like a drug. Our nation is a drug user. Ultimately, we want to get by taking the least possible amount of this drug, because its use usually leads to societal weakness, dependency on handouts, malinvestment, misallocation of capital etc. Right now over 50% of our GDP is government spending, so our society is totally whacked out on this drug. So the financial crisis comes along, which gives our drug user a bad case of flu. And after the flu our immune system is depressed, and we find ourselves with a lot of painful symptoms. I don’t think that that is the time to try and wean ourselves off the drug. I think we need to take our usual dosage, and give the drug user time to recover from the flu and the post-flu effects.
I am of the conviction that actually neither stimulus nor austerity is a good debt reduction measure, and the patient will keep getting flu so long as the total debt-to-GDP measure is elevated (Reinhart and Rogoff’s figure is 100%, which sounds about right). The only sure debt reduction measures are a full or partial debt jubilee, or hyperinflation or a liquidating crash.
Ultimately we will have to choose one of these options. Until then it seems pointless to incur any further pain on the patient, especially when the evidence shows that that pain will do nothing (or WORSE than nothing) to improve the debt-to-GDP situation. It’s just fiscal sadism.
I wish we had an austerity-minded administration during the last boom. I wish David Cameron was elected in 2001. I wish Ron Paul had taken office in 2001. That was the time (2002-06) for austerity.
Many times countries don’t impose austerity as a choice, but because they have to. For example, no one will trust to lend money to country X anymore so they will have to get the money from IMF to cover their shortfalls which will in turn want to see that the country is doing something to get out of the current situation and become self-sustainable again.
The same can happen even without IMF’s involvement for more trustworthy countries: bond holders will trust an austerity-minded leadership during a recession but would otherwise rebel and force bankruptcy. This bankruptcy is probably the equivalent of your jubilee, but don’t think that things will be all rosy after a country goes bankrupt, it may be catastrophic. It’s all a matter of choosing the type of pain you want to endure.
AEP thinks the above is the case for UK: http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100013002/paul-krugman-and-cameron%E2%80%99s-realism/ (I’m not at all a fan of AEP)
PS: It’s debatable whether AEP or Krugman is right here (though I tend to favor AEP’s approach of erring on the side of caution) but what fascinates me is the kind of flawed logic Krugman uses to derive his conclusions. He says:
“The Cameron government likes to point to low British interest rates — which are not just the result of safe-haven flight into the bonds of every advanced-country government that still has its own currency. Except, actually they are”
How is that a proof? Those trends can be interpreted in a million ways that would favor AEP’s thinking; for example: “flight to safety to all countries still deemed credible and safe”. I truly believe that the unprepared people reading Krugman can become intellectually damaged. That’s all I wanted to say with this second comment – note that I do not ultimately think I have enough evidence to fully support either Krugman or AEP, but gun to my head I’d do what Cameron and AEP would do.
AEP seems to have read a few reports from Unicredit and taken them at face value:
Yeah, except Unicredit clearly didn’t understand why the nations in the Eurozone were getting pummelled. It had less to do with the debt levels themselves, and more to do with the fact that they didn’t have their own central bank to kick their can. Japan and Britain have the worst total-debt-to-GDP levels in the world, and yields are still very low in both. My feeling is that this will be the case unless there is a breakdown in their physical economies (e.g. due to a war or a trade war or domestic disruption). I think Britain and America could print massively more money without hyperinflation or rate spikes if the Chinese goods, and Arabian oil keep flowing.
Buddy, I laughed at the survivalists too until recently, but not so much anymore. In particular, I’ve begun storing some commodities, not to escape Armageddon, but for economic reasons. Foregoing 0.5% bank deposit interest, and using my cash to buy a stockpile of something that I need to buy on a regular basis (like tobacco, for example) which is inflating at 5-10% p.a. is a no-brainer.
Tobacco is a very good commodity to trade. If you have enough storage space I’d say that is a very good investment.
John, you are a genius. Lets hope that Tobacco is not made illegal, but every war movie story has someone asking for a cigarette.
I was thinking of stockpiling diesel on my farm. I grew up watching Mad Max (Australian film on the end times when civilisation collapses) and fuel was one of those commodities. Petrol.Benzine deteriorates. Diesel stores well.
The problem I see with your argument is that as most of the people you look at the data for a very short timeframe.
I think it is totally normal to get contraction in almost everything when you go for austerity (Living within you means is not a bad thing as most economist try to portray it). As long as government drop spending simultaneously with the austerity and don’t increase taxes and most importantly don’t interfere with the private market this is a good direction.
Of course it is probably OK in this short time period to have some spending on helping the poorest ppl, but no longer than 1 … 2 years max. More than that it becomes entitlement.
Take example of the 1920-21 recession in USA, it was quick, and resulted in the booming 20’s.
If the metrics we are using to measure the success of such measures are consumer confidence, business confidence, and borrowing costs these are by definition short term measures.
If the metrics we are using are the longer term ones — overall debt levels, and overall deficit levels — then we already know austerity will fail, because contractionary fiscal policy correlates very strongly to lower tax revenues, which means bigger deficits and ultimately more debt.
Under a fractional reserve banking system where money is debt, this will generally be the conclusion. If government could drop taxes at the same rate they drop spending there might be a stronger case.
Don’t interpret this as me being pro-stimulus or pro-Krugman.
The bigger conclusion here is that a system that cannot withstand contractions, and where “living within our means” is actually dangerous is a bad system.
Is there a book or paper on the effect of Keynesian policies, minus the saving by government (Sovereign wealth fund) in boom times.
The Australian Government gave a $900 stimulus payment to all Tax Payers at the height of the GFC (To keep GDP up to ensure a 20 year boom was not disturbed by a technical recession-2 quarters of negative growth) but we did not have a big enough surplus, now we are in debt. I agree it kept confidence high, and many businesses continued as “business as usual” in anticipation of the flow on effects. But now if we have a slowdown, the government is hamstrung.
Isn’t the main flaw of Keynesian philosophy, the ability of the government to justify spending to maintain employment? This is Socialism by stealth. The Greek Government has proven Keynesian policies without the saving in boom times, lead to failure. Even if the had a Drachma currency which devalued, the increase in exports would not pay off the Euro denominated debt. External borrowing will not work, as you can’t inflate away.
The main flaw with Keynesian philosophy is that many of the governments of the world never did save any “surplus” during the times of plenty. Yes, the US had a couple of years of surpluses (kinf of) and Greenspan actually said that the surplus would hurt the economy.
Some how, Neo-Keynesian economists have a hard time wrapping their head around 3rd grade logic.
“Down with Kings” I say.
That was a huge problem, but there is more too it than just that: Keynesianism completely missed (and continues to miss) the problem of the necessity of credit expansion in a debt-based monetary system.
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