Krugman's New Oracle at Delphi

As everyone knows, the Greek government is in serious trouble, and the nation's economy is taking a hit. Defaults are a terrible thing, and Greece is taking a page from Wall Street and demanding a bailout by the EU Central Bank. (Apparently, Germany is standing in the way, demanding -- Horrors! -- that the Greeks put their own house in order, something that the socialist Prime Minister George Papandreou is denouncing. Gee, why should socialists have to shoulder the costs of, well, being socialist?)

Not surprisingly, Paul Krugman has weighed in on the Greek crisis and at least some of his commentary has truth. Unfortunately, since many of his pronouncements seem to be something akin to the Oracle at Delphi, in which the Pythia (after sniffing some gas from a vent in the earth) would mumble something that the Greeks would hold as true prophecy, it is hard to separate what makes sense from what does not. My rule of thumb in examining anything Krugman says is to pay attention to his analysis of what is happening, but to ignore his Keynesian "solutions," just as the ancient Greeks should have ignored the priestess.

Like so many other countries, Greece drank the Kool-Aid Bubble, and now is experiencing the pain of the inevitable economic contractions that accompany the bubble's collapse. Krugman seems to recognize it, and he even declares (correctly) that "now it faces a prolonged era of grinding deflation as it works its way back to competitive costs."

I absolutely agree. However, what is Krugman's "solution" to this problem? Why, inflate, inflate, inflate. As I pointed out in my post on Krugman and Spain, Krugman laments the fact that Spain no longer can devalue its own currency, since it uses the Euro. This is like complaining that after the alcoholic checks into rehab, those mean people running the place will not let the guy imbibe in his "hair of the dog" solution to alcohol withdrawals.

Where Krugman and I differ is here: Krugman sees inflation as the solution, while I believe it is the problem. He sees nothing good coming from deflation, as he believes (as did Keynes) that it creates a permanent downward spiral. However, as I have written elsewhere, deflation begins with what we see to be "bad effects," but ultimately helps to put the economy back into order again.

Inflation, however, provides the "good effects" first, but ultimately deteriorates. Where Krugman is so very wrong is that he believes that the "good effects" can be made to last indefinitely, just as long as government has the "courage" to continue inflating its currency. In other words, the alcoholic can remain the "happy drunk" indefinitely, just as long as he can keep drinking! So, in the end, Krugman sniffs the gas and then makes a pronouncement that makes about as much sense as came from the Pythia.