Thursday, July 8, 2010

Krugman (Sort Of) Responds to "Regime Uncertainty" Arguments

Although Paul Krugman does not want to use the term "regime uncertainty," nonetheless, he seems to be referring to that argument in a July 7 post on business investment. He writes:
Truly, we live in a time of mass delusion — or maybe make that elite delusion — where there are lots of things that everyone believes, without a shred of evidence to back that belief. Here’s one more: everywhere you go, you encounter the claim that businesses aren’t investing, they’re just sitting on piles of cash, because they’re worried about future government policies.

There is, of course, a much more prosaic alternative: businesses aren’t investing because they have lots of excess capacity. Why build new structures and buy new machines when you’re not using the ones you already have?

So is there anything in the data suggesting that we need to invoke fear of government to explain low investment? Not a bit.
He goes on to present a graph that contrasts business investment with the CBO's estimate of the gap between potential GDP and real GDP. Since the pattern of the investment follows the CBO's "gap," according to Krugman, that is the end of the argument.

Krugman's argument is based upon the following sets of questions and answers:

Q: Why is the economy bad?

A: Because businesses and individuals are not spending as much as they used to spend.

Q: Why aren't businesses and individuals spending like they used to spend?

A: Because the economy is bad.

Q: What would make the economy recover?

A: Businesses and individuals have to start spending again.

As you can see, this is a circular argument, and Krugman bases much of his analysis upon such "logic," yet he claims that people who disagree with him are suffering from "mass delusion." Now, I don't doubt that businesses as a whole are going to invest less during a recession, but Krugman is leaving out some important matters.

The "capacity" argument is not really an economic argument at all. First, it operates on what Austrian economists call the view that factors of production (for analytic purposes) are homogeneous. Second, "capacity" is a theoretical term for the capability of a firm to create output provided that all factors were operating at "full employment."

The idea behind the Keynesian emphasis on "capacity" is that government can "stimulate" the economy to a point where all firms are operating at full capacity, which then signals that we have arrived at a full-employment Nirvana. Of course, this argument contains the assumption that "stimulus" spending affects all sectors of the economy equally, as though an economy is a homogeneous mass of factors.

I have read a number of Robert Higgs' articles and papers, and never once have I seen him resort to the straw man characteristic of Barack Obama as a "socialist." For that matter, he did not call FDR a "socialist" in his "regime uncertainty" paper published 13 years ago.

If, indeed, government spending is what drives a successful economy, then why was there not a "Great Depression of 1946-48" following the end of World War II, when real prosperity returned. Higgs writes:
Finally, this way (regime uncertainty interpretation) of understanding the Great Duration meshes nicely with a proper understanding of the Great Escape after the war. The Keynesians all expected a reversion to depression when the war ended. Most businesspeople, in sharp contrast, “did not think that there was any threat of a serious depression” after the war (Krooss 1970, 217). The businesspeople forecasted far better than the Keynesian economists: the private economy blossomed as never before or since. Official data, which understate the true increase because of mismeasurement of the price level, show an increase of real nongovernment domestic product of 29.5 percent from 1945 to 1946 (U.S. Council of Economic Advisers 1995, 406). Private investment boomed and corporate share prices soared in 1945 and 1946 (Higgs 1992, 57–58). None of the standard explanations can account for this astonishing postwar leap, but an explanation that incorporates the improvement in the outlook for the private-property regime can account for it.

From 1935 through 1940, with Roosevelt and the ardent New Dealers who surrounded him in full cry, private investors dared not risk their funds in the amounts typical of the late 1920s. In 1945 and 1946, with Roosevelt dead, the New Deal in retreat, and most of the wartime controls being removed, investors came out in force. To be sure, the federal government had become, and would remain, a much more powerful force to be reckoned with. But the government no longer seemed to possess the terrifying potential that businesspeople had perceived before the war. For investors, the nightmare was over. For the economy, once more, prosperity was possible.
One does not have to believe Obama is a socialist to understand that the anti-business rhetoric coming from the White House and Congress is having a chilling effect upon long-term business investment. For example, Obama's claim that his administration would "create 700,000 'green' jobs" does not point out that government subsidies to companies not capable of turning a profit ultimately must come from the hides of presently "healthy" companies, and one can be assured that this "plan" actually would destroy more wealth (and jobs) than it would create. 

Yet, instead of trying to understand a differing point of view, we see vengeful politicians now being urged to seize the funds of individuals and businesses in order that government "may better spend it." No doubt, that will create real prosperity.


abellia said...


This "circular logic" argument is tired.

First of all, the economy IS circular. Money has to move from consumers to producers and back again for things to function. If this doesn't happen, the circle of life stops.

How could you fix our currently deflated circle? Well, one party or the other would have to transfer some money: either the producers would have to speculatively invest, which would result in hiring, which would result in a transfer from producers to consumers who would spend, which would transfer money to producers...

Or the consumers would have to start buying stuff with the money they've saved... but wait, they don't have any.

There is a third possibility - the government could tax the people who have money but aren't spending it on investment or otherwise, and do the investing itself -- in education, infrastructure, research not being done by private industry...

Government "investment" isn't perfect, but neither is that of private industry.

AP Lerner said...

Ok, so over the last few weeks, Prof. Anderson has shown he does not understand the monetary system (by comparing SS to a Ponzi scheme), refuses to believe reserve accounting exists, and the accounting identity:

net household financial income = current account surplus + government deficit + Δbusiness non-financial assets

Completely ignores data that goes against his convenient regime uncertainty argument

and now he is claiming "capacity" is a theoretical term. Huh? Sorry, but the factory down the street laying off workings and churning out less product is not theoretically operating at a lower capacity. It is operating at lower capacity in reality. Just ask the guy they laid off.

Is this what qualifies as economics at Frostburg? Ignoring basic accounting and creating 'new' theories?

Xatrucho said...


It's the Circle of Life
And it moves us all
Through despair and hope
Through faith and love
Till we find our place
On the path unwinding
In the Circle
The Circle of Life

Anonymous said...

Q: Why is the economy bad?

A: Because businesses and individuals are not spending as much as they used to spend.

Q: Why aren't businesses and individuals spending like they used to spend?

We had housing bubble worth trillions of dollars collapse, which caused a huge fall in yearly aggregate demand. This is how I believe Krugman would respond.


Q:What would make the economy recover?
The demand gap between before the recession hit and now needs to be filled.

Richard said...


"This is how I believe Krugman would respond. "

No kidding. He backed money printing to lower interest rates back in 2001, which led to the housing bubble.

How about we stop doing the same thing that caused the housing bubble in the first place - printing money in the name of lower interest rates?

Anonymous said...

The green jobs program was a huge success in Spain: The government report does not expressly confirm the highest-profile finding of the non-governmental report: that Spain’s “green economy” program cost the country 2.2 jobs for every job “created” by the state. However, the figures published in the government document indicate they arrived at a job-loss number even worse than the 2.2 figure from the independent study.

antidentite said...

i am probably out of my league commenting on what appears to be a very contentious blog, but i would just like to put in my two cents and reiterate what Richard just posted.

first @abellia, the circle of life of money is bound to become overgrown when the fed keeps interest rates artificially low, as they did during the housing boom.

second. @anon, "The demand gap between before the recession hit and now needs to be filled." don't you realize that the gap was created by people spending money they did not really have because the fed artificially kept rates too low? please look around you, there are people making far less than myself living much more extravagant lives, and this is during the current was even worse during the "boom".

Prof. Anderson may or may not be correct in his theory of "regime uncertainty" causing the present economic uncertainty (personally, i think it has exacerbated the problem but the underlying tensions where present well before), but i cannot ignore the role of the fed in the entire debacle...basically, JMKeyes was wrong, you cannot print money without mistakes and consequences. my limited reading of history has shown that all fiat monetary policies have ended in failure. please provide an example of one that has not, i am open to enlightenment.

Chuck said...

First to abellia...Demand does not an economy make. In order to purchase anything, first you must produce something. Borrowing money has only given us the illusion of prosperity. We are not producing enough to justify the levels of consumption we have enjoyed. Now it is time to pay the piper...

As for AP Lerner, just what is the flavor of the kool-aid you are drinking?

Another Anonymous said...

Criticizing someone for circular logic that way is very poor logic indeed. There are circular arguments and circular arguments. Krugman's is a virtuous circle - it is internally consistent. The bad kind are vicious circles, which are inconsistent. Krugman is just pointing to the self-reinforcing nature of depressions, the paradox of thrift, etc. which are very hard for nonideologically motivated people to deny. And experience does show that Keynesian, New Deal policies work and create prosperity. It was when the US and the world abandoned them around 1980, abandoned full employment as a goal, irrationally privileged monetary over fiscal policy that the US and the world ended the great postwar boom. What are the countries who have had big Keynesians stimulus programs - China, Australia, more recently S Korea. And they have worked, far more than the austerity or ideological denial of aggregate demand deficiency. I might agree if stimulus money were spent as badly as much US government money is spent, on murdering innocent people in insane wars for no reason at all, to bribing rich parasitic corporations to further wreck US healthcare (instead of the simple, obvious, cheaper, more efficient and effective solution of Medicare for all) that it might be better not spent. But it is precisely the rational objectives of stimulus proposals - not firing schoolteachers and cops, public works, etc. that create opposition. By the way, AP Lerner apparently drinks the pro-arithmetic, pro-accounting, pro-logical consistency brand of Kool-Aid.

Barking Cat said...

The term "paradox of thrift" is just verbal trickery. Obviously "paradox" is preferable to the more accurate term "logical contradiction."

"And experience does show that Keynesian, New Deal policies work and create prosperity."

Really? The New Deal did not work to create prosperity. Keynesian economics did not work in the 1970s and did not work in Japan in the 90s. And it is not working in the USA today.

"What are the countries who have had big Keynesians stimulus programs - China, Australia, more recently S Korea. And they have worked, far more than the austerity or ideological denial of aggregate demand deficiency."

I will concede this: under certain conditions, and in the short-run, it does work. It worked in 2001 when the Bush administration was gifted a budget surplus. And it is working in Australia, Korea and China for the same reason, they started from a strong fiscal position. But it ceases to work when governments have to run up large deficits. The recent crisis in Greece was a sobering case-study for the Europeans, and they have (wisely) decided to step back from the Keynesian abyss.

You may find this chart of interest, it is taken from a recent article in The Economist magazine:

Max said...

Does Mr. Krugman teach in kindergarten or why do his charts miss any kind of axis labeling?

IS this the quality of research that is done in the elite institutions Mr. Krugman worked for?

Is this the level of expertise a noble price winner has when it comes to basic scientific things like creating a graph?

If his expertise in economics is as sloppy as his handy work, then this guy is not a good representative for economics.

burkll13 said...

@Barking Cat and An Anon:

Its somewhat true that Keynesian policies work in the short run because, yes, it has an effect on spending. the problem is that it alters the structure of the economy. they work to "fix" the economy by creating bubbles. What is going to happen when the roads get fixed? all those jobs "created" with that project will disappear when that demand disappears, unless they just keep the program going on forever. what brought us here was an over abundance of resources directed into the housing market. Too many houses built by too many developers, funded by too many banks. now the structure needs to be adjusted by liquidating all that bad debt.

meanwhile, while negatively affecting the economic structure of the economy, those policies are negatively affecting the dollar as well.

working in "aggregates" doesnt give you the full story. it doesnt give you the How or the Why.

AP Lerner said...

"As for AP Lerner, just what is the flavor of the kool-aid you are drinking?"

Kool Aid made up of facts, data, and reality. Something missing from this blog. Facts are facts, and data is data, and Prof. Anderson repeatedly ignores facts and data to form an opinion, instead of using facts and data to form an opinion. I believe this is called being a hack.