Krugman, Keynesians, the Austrians, and the Housing Bubble

In a blog post, Paul Krugman points out that a number of "austerians" (people who believe we need to have fiscal and monetary responsibility) did not see the "housing bubble" approaching -- and he did. Therefore, according to Krugman logic, "austerity" must be bad.

As I see it, the logical construct goes this way:

1. The "austerians" were wrong on the housing bubble;
2. Krugman was right on the housing bubble;
3. Therefore, we need lots more government spending because Krugman believes that is what we need.

This is a classic non sequitur, and I hate to say it, but Krugman's correct view of the bubble does not mean he is correct today. The rightness or wrongness of his argument depends upon both the application of laws of economics and the current situation, period.

Now, in looking at the whole housing bubble business, let me say that I am not going to jump on Krugman's 2002 comment about Alan Greenspan needing to create "a housing bubble to replace the NASDAQ bubble." Krugman has denied that he was advocating such a bubble, and I am willing to take him at his word.

Nonetheless, there are two things that need to be discussed here. The first is the fact that the Austrians, and specifically Mark Thornton, were out in front to call the housing bubble what it was. Thornton wrote in 2004 that the housing market was "too good to be true," and also had this article in February 2004 that buttresses his claims.

Yet, Professor Thornton also is an "austerian," at least in Krugman's definition. He also predicted and recognized the housing bubble long before even Krugman made mention of it. So, there seems to be a crack in Krugman's rejection of "austerity" measures for the economy.

Before going further, however, I need to point out that Austrians are not "austerians" in the mainstream (or statist) view of economics. Austrians believe that the market should be free to sort out the malinvestments that came with the boom, and for the necessary liquidation and repositioning of assets to occur. This is quite different than the view that GOVERNMENT should be IMPOSING austerity. In the Austrian view, the government role is passive while in the mainstream view, government is active in its imposition of policies.

(I need to point out that Krugman rejects both viewpoints. Government needs to be active, showering new money, encouraging spending, and doing lots of borrowing and spending itself, according to Krugman.)

My second point is more theoretical. Keynesians deal solely in aggregates, because they believe that if government both engages in generalized spending (and encourages consumers and businesses to do the same), the economy will recover and grow to full employment -- provided the spending is great enough. However, Keynesianism does not have any kind of coherent capital theory, and I don't see how one can have a bubble, which constitutes a malinvestment in the Austrian view, AND, at the same time, claim that all that is needed is spending.

As I have written many times before (and I am hardly the only Austrian to be saying this), the Keynesian view implies that factors of production are homogeneous, and that it does not matter what kind of spending takes place, just as long as there is adequate spending. This cannot logically square with the creation of bubbles, since asset bubbles are specific and they clearly are malinvestments, yet Krugman continues to deny any theory that includes malinvestments.

Furthermore, Krugman knows that one cannot sustain a bubble, since bubbles by their very definition are not sustainable. Yet, he seems to be arguing that we need to both try to sustain this bubble, or at least not let housing prices fall, and, at the same time, recognize what a bubble really is. These two views are mutually exclusive.

So, in both sets of arguments, I believe that Krugman is using a non sequitur, nor does it surprise me he is doing so.