Thursday, May 2, 2013

Yes, Krugman, Empower the Inflation Fairy

Lest anyone think that Paul Krugman is an economist, his latest column bemoaning the lack of hardcore inflation presents every reason as to why he is a crank, although a famous crank. Yes, the Inflation Fairy has the answer: sprinkle magic dust and watch it turn into money, lots of money. We'll all be rich!

Let us read Krugman in his own words: this point, inflation — at barely above 1 percent by the Fed’s favored measure — is dangerously low.

Why is low inflation a problem? One answer is that it discourages borrowing and spending and encourages sitting on cash. Since our biggest economic problem is an overall lack of demand, falling inflation makes that problem worse.

Low inflation also makes it harder to pay down debt, worsening the private-sector debt troubles that are a main reason overall demand is too low.
But it gets better:
So why is inflation falling? The answer is the economy’s persistent weakness, which keeps workers from bargaining for higher wages and forces many businesses to cut prices. And if you think about it for a minute, you realize that this is a vicious circle, in which a weak economy leads to too-low inflation, which perpetuates the economy’s weakness.

And this brings us to a broader point: the utter folly of not acting to boost the economy, now.
One can surmise that Krugman really believes that if Ben Bernanke were to unload his proverbial helicopter and shower Americans with lots of money to the tune of, say, a million dollars apiece, then the economy would have plenty of demand and everyone would be rich. It would be so easy. Granted, the Inflation Fairy would have a beard and her wings would look like helicopter rotors, but she still could turn magic dust into money.

There is another reason I say Krugman is no economist, and the following statement demonstrates my point:
From the beginning, it was or at least should have been obvious that the financial crisis had plunged us into a “liquidity trap,” a situation in which many people figure that they might just as well sit on cash. America spent most of the 1930s in a liquidity trap; Japan has been in one since the mid-1990s. And we’re in one now.

Economists who had studied such traps — a group that included Ben Bernanke and, well, me — knew that some of the usual rules of economics are in abeyance as long as the trap lasts. Budget deficits, for example, don’t drive up interest rates; printing money isn’t inflationary; slashing government spending has really destructive effects on incomes and employment.
Perhaps the most important "rules" of economics to be "suspended" by a "liquidity trap" is the Law of Opportunity Cost and the Law of Scarcity, or so Krugman would have us believe. Interestingly, he wants us to believe that by the simple act of printing lots of money, government essentially is creating real wealth, as in Krugman's view, governments self-generate wealth.

For all of the Keynesians out there who believe that the real problem is "idle resources" that can be "stimulated" by government doling out lots and lots of new cash, one must remember that after the new money has been farmed out to the economy, people will act, whether they pay down debts or use it to spend on consumption goods.

However, what they want us to believe is that after the Inflation Fairy unloads her magic dust and people have gone on a spending spree, somehow the economy then will magically arise and move forward. All that was needed was some "pump priming"!

But why should that be the case. Why should the act of dumping a lot of new money on people give long-term revival to the economy? How is it that a bunch of new money the first time around would awaken the owners of those "idle resources" but not be needed for round two and beyond? Krugman writes of the economy "gaining traction," but he never explains what it means.

This last point is important, for Krugman and his followers want us to believe that after a massive round of distributing new money (and the new money always goes to those most in need), the prosperity that follows will move into ever-widening circles and spreads employment to the unemployed. In other words, Krugman wants us to believe at least a little bit more inflation will bring hope:
I wrote recently about how, by allowing long-term unemployment to persist, we’re creating a permanent class of unemployed Americans. The problem of too-low inflation is very different in detail, but similar in its implications: here, too, by letting short-run economic problems fester we’re setting ourselves up for a long-run, perhaps permanent, pattern of economic failure.
It has been a long time since an economist was publicly willing to claim that inflation would bring prosperity, give that a lot of us still remember the huge inflation that occurred around 1980, and it was not a wonder drug. (Krugman would argue that we were not in a liquidity trap, so the laws of economics were different.)

But here is the problem: over time, a new bounce in the economy becomes dependent upon yet another round of inflation. At first, inflation seems to be a miracle cure, as no doubt a bunch of new money in the hands of at least some people will make them better off relative to others. They will spend or maybe pay off some debts and be able to purchase things at prices that reflect the time before the surge of new money. (It takes a while for the money to work its way through the economy and finally push up prices, although the process of increasing prices will be uneven.)

But then what? Because it was the inflation that produced the temporary surge in activity, the only way to replicate the economic bounce is to inject another round of new money. This time, the "good" effects are not quite as good and the "bad" effects become a little more pronounced. One can understand what happens as this process is repeated time and again.

When the 1960s began, even though the economy was in a recession, nonetheless times overall were pretty good and inflation was low. As the government began to grow massively during the next decade and the American military venture into Vietnam metastasized, the government, through the Fed, turned to more and more inflation. By 1965, all silver coins were gone (although the government insisted that the new "sandwich" coins were just as valuable as the old silver ones), and by 1971, there was a monetary crisis.

The theme of Krugman's column is that inflation itself can bring prosperity to an economy languishing in a "liquidity trap." I have no doubt that a massive injection of money into the hands of people like me would have a stimulative effect -- at first. As I noted before, this would not be real prosperity, but rather a trap. Unfortunately, Krugman really does believe that inflation -- the debasing of the marginal unit of money -- is the key to a new prosperity.

And it all comes out in three words: not enough inflation. It is better spoken in two words: Inflation Fairy. Or maybe it is better spoken in one word: insanity.


ayassos said...

It certainly worked, so I hear, at the Washington D.C. babysitting co-op. The babysitters got traction; why not the entire American economy? They're virtually identical, or will be when the babysitting gets offshored to China.

Cato said...

Krugman writes of the economy "gaining traction," but he never explains what it means.

Exactly. Krugman never discusses logistics, for precisely the reasons Anderson points out.

But what we see in place of logistics is the kind of attempts at intimidation of his readers that we expect from an academic who cannot flunk or fire anyone who disagrees with him.

If you are a reader that has a question, just remember that about this subject only stupid/evil people have questions ("as should have been obvious"), and that there is no one whose word you are better qualified to take than his ("a group that included Ben Bernanke and, well, me").

Anderson has trouble seeing Krugman as an economist. I have trouble seeing him as a three-dimensional adult.

Anonymous said...

Hi Professor Anderson,

You refer to the "Law of Opportunity Cost" and the "Law of Scarcity".

To help me better understand this post, can you please provide your definitions of these terms? Thanks.

William L. Anderson said...

Opportunity cost can seen here:

Scarcity here:

Krugman assumes that because resources are "idle," the government through "costless" or "near-costless" borrowing and money printing can make those resources employed.

Keynesians say that lack of "aggregate demand" causes such unemployment while Austrians look to malinvestments (at first) and then see how government actions actually raise the cost of employing those resources.

Anonymous said...

I'm with Cato. I'm tired of giving Krugman the benefit of the doubt of being anything remotely resembling an intellectual, an economist, or anything similar....

He's incredibly myopic, naive, dishonest, and well, you get the idea.

Anonymous said...

There's this guy at the following blog that goes by the name dcpetterson (he's both an author/editor and regular commenter) who is making some wildly inaccurate and wholly outlandish claims about Austrian Economic Theory. I'm no longer welcome there, but it'd sure be nice if someone would step in and take him and his friends down a notch or three. See for yourself the childish BS he's been spewing.

Bob Roddis said...

I continue to maintain that the vast majority has no clue that inflation is not an unchangeable mysterious force of nature but a purposeful government policy with the intended purpose of stealing their purchasing power. Getting that message out so that the public has an instanteous understanding of it is essential but perhaps sufficient to defeat the Keynesians. But it is still necessary and such understanding still has not yet occurred.

Anonymous said...

Bob, I wholeheartedly agree. My view on Deflation is that it is simply the Market's way to bring prices in line with what people can afford in a depressed economy. The Government tries to make us think this is a problem, and steals this purchasing power. If falling prices really kept people from buying things nobody would own a computer or a cell phone.

Pulverized Concepts said...

The nation/state needs funds to purchase the votes of citizens by putting them to work welding up aircraft carriers, counting unwed mothers and teaching adolescents that the government has all the answers. Stealing the wealth of the productive through taxation, or even bond sales, can't supply all the money necessary to buy those votes so they must enpixelate even more. Sane people feel that money must represent wealth, Keynesians don't see the relationship. To them, the money itself is wealth, even though as more is enpixelated it comes to represent fewer assets. And that's the real point, the money itself has value only in its relationship to an asset. Those who own the assets, land, cattle, oil, coal, etc. will be wealthy regardless of the purchasing power of money. Eventually, if Steve Schwartzman doesn't convert his bank deposits to real asset ownership, he'll be just as broke as the homeless guy with the cardboard sign down on the corner.

Bala said...

Prof. Anderson,

Please note that he says that injecting money into the economy will not be inflationary. I am pointing to the fact that he considers inflation to be price rise rather than the increase in the money supply itself. That's a rather big and fundamental difference that I thought merits being pointed out.

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