Monday, December 6, 2010

Krugman Seeks the Herbert Hoover "Solution" to Depression

In 1932, the U.S. economy was in a depression with double-digit unemployment, and the end was not in sight. President Herbert Hoover, faced with both an imploding economy and growing budget deficits, Hoover opted for the Paul Krugman solution: raise taxes.

We know how this story came out. The tax increases not only failed to raise the revenue, but the nation's unemployment rate went up even faster, peaking at 28 percent in February 1933, a month before Franklin D. Roosevelt was inaugurated as Hoover's replacement.

This bit of history has been shoved down the Orwellian Memory Hole by politicians, "distorians," and economists. In his column today, Krugman continues that sorry tradition.

Before going on, I will say that I am not impressed by the Republicans' "low-tax" rhetoric, given that government spending itself is a tax. (One does not even have to hold to perfect Ricardian Equivalence to make that statement.) Nonetheless, I don't think that Krugman's argument here is valid, and the premises from which he builds his argument are ridiculous.

As a "macroeconomist," Krugman operates from a completely different set of "opportunity costs" than what the Law of Scarcity describes. In Krugman's view, the "cost" comes when an individual keeps money he or she has made instead of having it confiscated by the government. (The Keynesian Balanced-Budget Multiplier "proves" that tax increases always have a positive effect and are more economically efficient than the result when individuals keep their money.)

Thus, when money is not confiscated from productive people, that is a "cost" to the country. Obviously, it would not take long to create the Reductio ad absurdum scenario, and I don't think that the person who told a roomful of economists in November 2004 that the pre-1981 70 percent tax rates were "insane" is going to agitate for super-high tax rates. At least not yet.

However, Krugman seems willing to accept anything the Congressional Budget Office produces (at least when the CBO is under control of the Democrats), and I will say that the semi-rosy scenario he claims would be the case if all tax rates rise to their pre-2003 levels is fantasy. He writes:
A few months ago, the Congressional Budget Office released a report on the impact of various tax options. A two-year extension of the Bush tax cuts, it estimated, would lower the unemployment rate next year by between 0.1 and 0.3 percentage points compared with what it would be if the tax cuts were allowed to expire; the effect would be about twice as large in 2012. Those are significant numbers, but not huge — certainly not enough to justify the apocalyptic rhetoric one often hears about what will happen if the tax cuts are allowed to end on schedule.
How the CBO even can come up with something like this is ridiculous on its face. It really seems to be based upon the belief that individuals don't change their behavior at all when taxes are increased or decreased.

Now, I have not read any apocalyptic predictions on the pro-tax cut side, although Krugman has been throwing out enough doom to make up for any ridiculous claims from the Republicans. For example, he writes:
But while raising taxes when unemployment is high is a bad thing, there are worse things. And a cold, hard look at the consequences of giving in to the G.O.P. now suggests that saying no, and letting the Bush tax cuts expire on schedule, is the lesser of two evils.

Bear in mind that Republicans want to make those tax cuts permanent. They might agree to a two- or three-year extension — but only because they believe that this would set up the conditions for a permanent extension later. And they may well be right: if tax-cut blackmail works now, why shouldn’t it work again later?

America, however, cannot afford to make those cuts permanent. We’re talking about almost $4 trillion in lost revenue just over the next decade; over the next 75 years, the revenue loss would be more than three times the entire projected Social Security shortfall. So giving in to Republican demands would mean risking a major fiscal crisis — a crisis that could be resolved only by making savage cuts in federal spending. (Emphasis mine)
This really is akin to the scene in "Animal House" in which the band tries to march through a wall. Does Krugman really believe that the ONLY change would be revenues, and that the U.S. economy would perform just as before with the only difference being that the government would be in possession of $4 trillion more than if the lower rates remain? Furthermore, when government takes money from individuals, does that mean that the "country" always is better off?

This is an interesting line of thinking. According to Krugman, the government is the "country," and the "country" is us. So, if the government has more money, then "we" always are better off -- except for those millionaires who always gain their wealth at the expense of everyone else.

There is nothing in Krugman's writings that would suggest that the optimum tax rate would be 100 percent on ALL private income. I am serious. If Krugman's view of the "country" is the government itself -- and his language points to that belief -- then the "country" is at its best when it has everything that everyone has produced.

Now, I doubt that even Krugman would be willing to give us this kind of scenario, although I never have read anything from him in recent years that would refute it. Instead, he tries to convince us that if individuals are permitted to keep $4 trillion of income (which I doubt would be the case -- those are unrealistic numbers, in my view), that it would be a "cost" to the "country." However, if the government is permitted to confiscate that $4 trillion, then we are better off, since "we" would be the "country."

In Krugman's world, if an individual is permitted to keep any income, that is a "cost" to the country, and even though the individual is made worse off if the money is confiscated, it is a "benefit" to the "country," given his own rhetorical definitions. So, we can have the scenario in which all individuals are made worse off, but the "country" is made better off.

That is economics? I don't think so. It is nothing but absurd set of political talking points.


James E. Miller said...

Its great how Krugman states that Republicans used the dirty trick of "reconciliation" (he doesn't call it that by name) to pass the tax cuts when Democrats did the same thing to pass Obamacare, which Krugman happened to support. He called the tax cuts irresponsible and that the Senate rules existed to prevent such irresponsibility, but of course Democrats were incredibly responsible in passing Obamacare by the same method. I was only 12-13 when Bush passed the tax cuts but I bet more of the public supported them than people did Obamacare

A self described "tax and spend liberal" college professor I have said most of his political friends say Krugman doesn't know sh*t about politics and that his economic friends say Krugman doesn't know sh*t about both economics and politics. Chris Dodd even said he doesn't agree with what most of Krugman says. I just have to wonder, who actually takes this guy's words as the gospel?

The_Orlonater said...

I remember I was watching a segment of PBS' NewsHour with Jim Lehrer and they had Jeffrey Miron debating this Keynesian economist from the CAP and one of her remarks explaining opportunity cost was that it's the highest valued forgone opportunity and her example used to back to make it "clearer" was that what is the highest valued opportunity that "we" will miss out if the government allows those tax cuts to expire. In her viewpoint, opportunity cost applies to intellectuals and governments forgoing their most highly valued plan.

Bob Roddis said...

The Orlonater has it right. Krugman's rantings are really nothing more than National Socialism Philosophy 101. His rantings really have nothing to do with economics at all:

It's just so horrible if us really cool smart special people aren't allowed to run the lives of the ignorant rabble. What a lost opportunity!

Mark Hubbard said...

Hi William, not related to this post, I'm sorry, but a query all the same I'd love to read your opinion on.

I watched the 60 Minutes interview with Bernenke last night (I'm in New Zealand, so don't know how old it was). In it he said that QEII was not inflationary because it was not increasing the money supply: all it was doing was lowering interest rates.

I don't understand that at all:

a) The Fed has the cash rate to influence interest rates.

b) More importantly, the Fed buying Treasury bonds does increase the money supply doesn't it? Why does a government issue bonds other than to raise money, and the Fed is not using existing money to buy bonds, it's book entries surely which must have the effect of increasing the money supply (ultimately, at least), and hence are inflationary?

What am I missing?

Anonymous said...

@James E Miller: This guy-

@Mark Hubbard: It's only confusing if you assume Bernanke is being up front and honest in all his assertions.

Another Anonymous said...

@ Mark Hubbard :

QEII didn't increase the money supply: Depends on how you define "money". In the sense of dollar financial assets - it is just exchanging one asset for another. Bernanke is using inflationary to mean price-inflationary, as is standard. That people have the same amount of money, but more in checking (dollars) rather than savings (bonds) is not going to cause them to go crazy spending and push up prices. The fact that QEII was not inflationary shows that it was completely pointless.

Why does a government issue bonds other than to raise money?

The government can create all the bucks it needs. (In fact the Treasury secretary could pay off the national debt tomorrow, under current law.)

The only reason for a monetarily sovereign state like the USA to issue bonds is to monkey around with interest rates. Deficit spending would cause short term rates to go to zero, so bond sales or the like are needed to pull rates above zero.

Count to 10 said...

Any time the FED prints money to buy anything, it is pushing in the direction of inflation (though other factors can keep prices from inflating immediately).
Any time this is done to buy US Treasury bonds, it effectively allows the government to finance itself by printing money. This harms those who hold on to cash money. Further, if the bonds are being bought from bond holders rather than directly from the government, the bond holders profit (as they are doing this of their own free will).

Lord Keynes said...

Any time the FED prints money to buy anything, it is pushing in the direction of inflation

Not if the money is just held at the Fed as excess reserves.

Libertarians can't distinguish properly between the (1) base money and (2) broad money stock.

Just because you increase base money does NOT mean the broad money stock will also rise by an equal amount - or even by a significant amount.

For example earlier this year, M3 was actually contracting despite QE 1:

QE created money has to be injected into the economy by debt to inflate the prices of commodities.

But credit/debt is precisely what has collapsed - banks don't want to lend much and business and individuals don't want to borrow much either.

It's the failure to understand this that causes this sort of clownish, hapless Austrian nonsense:

Marc Faber with Peter Schiff - Hyperinflation In The United States A 100% Certainty,

ekeyra said...

Awwww theres LK. I was starting to get worried, like when you dont hear that 2 pound chihuaha barking incessantly you wonder if something happened to it.

Anonymous said...

Lord Keynes, correct me if I am wrong, but isn't it true that it does not matter how much stock of money there is?

When land, labour, and natural resources will remain just as scarce irrespective of how much money there is, the fall or rise in money supply will not change the scarcity of those resources and thus improve their allocation to productive uses.

As it is, when banks start recalling loans or when people stop borrowing, it's not like it's a permanent state - they have merely decided to lend or borrow in the future rather than now, no?

Please note that I am not making this post with an aggressive or contentious tone; I am really curious to hear what you have to say, and I respect your strong arguments as much as I do Bill Anderson's.

Another Anonymous said...

Anonymous - what you are saying is called the "neutrality of money". (Neo)classical economists believe in it. Sensible ones don't ( including Keynesians, and Austrians too, I think) Keynesians say that in a depression, like right now, there is a lot of land, labor and natural resources whose owners would just love to have them used, if they could find someone with the truly scarce thing, money, to allocate to them. In a depression, land, labor and resources aren't scarce. Money and jobs are. Land and resources will stay there, so the loss isn't gigantic. But labor vanishes if it is not used, which is why the government should guarantee full employment, like it used to, more or less, in the postwar golden age. The gov has an infinite amount of money, so it should cough up.

Sure, it's not a permanent state, except for people who lose their jobs and have them or their dependents die. Their pointless poverty and the work they don't get to do until enough people go bankrupt and prices and wages fall enough - which could take a decade or more - has permanent effects, all bad.

Anonymous said...

@Another Anonymous: Um, neutrality of money, as far as neoclassical economists utilize the theory, primarily has to do with real variables in the long run. Output is determined by resources and technology in the long run, whereas changes in money and liquidity can affect real variables in the short-run. You won't find anybody who thinks that a change in the money supply has a significant permanent effect in the long run, at least as far as the neo-classical models are concerned.

Why do I post this?

"Land and resources will stay there, so the loss isn't gigantic"

Makes me think you don't really understand money neutrality from the perspective of neo-classical economic models.

Anonymous said...

@AnotherAnonymous: It'd be nice if:

a. It was a simple matter of jobs and money being scarce, and

b. The government could simply prime the economy as if it were a pump.

The problem is that the government must determine where to allocate that money, and make its best guess as to what would be the most efficient use of that money. Then, it would have to make sure it prints the right amount. Failure to do the former would simply distort the capital structure in such a way that a future adjustment would be inevitable. Failure to do the latter would generate too much spending, and give off the impression that the recession was over, which would further distort the capital structure necessitating a later readjustment (or recession). To steal a quote from the latest Star Trek movie, "It's like trying to hit a bullet with another smaller bullet whilst wearing a blindfold and riding a horse".

Working from this perspective, it seems like it'd be less trouble in the long run to simply allow the economy to recover on its own, doesn't it? After all, for each time you fail, which you most likely will, you will call down another recession upon your head.

jgo said...

>> Any time the FED prints money to buy anything, it is pushing in the direction of inflation

> Not if the money is just held at the Fed as excess reserves.

And what are "excess" reserves, or even just "reserves"? They're the percentage of total deposits that the banks have to hold. The lower the reserves, the more loans the banks are issuing, i.e. the more "money" is in circulation.

So, whether they print FeRNs or increase the amounts in certain people's balances, or whether those balances are in terms of reserves makes no difference. In every case "money" is being created out of nothing, the currency is debased and, barring other hijinks, prices will go up.

It's that "other hijinks" part that bothers me. It's those "loans" to their buddies in the executive suites at Bank of India/Merrill Lynch, McDonald's, J.P. Morgan Chase (over $13G), Caterpillar, CitiGroup, Harley-Davidson, Dresdner Bank, WestLB, Deutsche Bank, France's BNP Paribus, Switzerland's UBS, Societe Generale, MetLife, Barclays, Lloyds Banking Group, AIG, Wells Fargo, Royal Bank of Scotland, Dreyfus, BlackRock, Pimco, Oppenheimer, Morgan Stanley, DWS, Janus and T. Rowe Price, Verizon Communications, Oppenheimer Institutional Money Market Fund, Ally Bank (GMAC), Chrysler Financial Services, Allianz SE's Pacific Investment Management Co., General Electric (over $16G) that bother me, especially when those executives were there in the Fed voting to give themselves that money.

jgo said...

"it does not matter how much stock of money there is?

When land, labour, and natural resources will remain just as scarce irrespective of how much money there is..."

Yes, it matters. In part, it matters because it undermines the "store of value" function of money, when a dollar is worth 1 ounce of gold one day and one thousandths of an ounce the next, when a semi-skilled laborer is told one year that only the extremely rich with incomes over 150% of median incomes will ever be taxed so much as 1% of that income but he wakes up to find a government hand has reduced his pay-check by a third or more.

It also matters because that newly counterfeited "money" isn't immediately spread to everyone. Some get it immediately, and can spend it at old price rates, while othes only get it after the prices have risen considerably, and those with large debts can pay them back with scrip that's worth less. IOW, the correspondence between value to the multitudes to the forgotten man, of land, housing, clothing, food, iPads, incandescent light... and his earnings and what he has to pay are disrupted. In this case, that disruption is intentional; it's part of the Keynesian "magic".

Anonymous said...

Jobs are scares because of a price floor on wages and subsidized unemployment.

Anonymous said...

@anon 10:13: I doubt that's the only or even primary reason for it, but it certainly is a contributing factor.

David said...

LK said,

QE created money has to be injected into the economy by debt to inflate the prices of commodities.

So did you, like AP Lerner, predict falling commodity prices?

Lord Keynes said...

So did you, like AP Lerner, predict falling commodity prices?

I personally didn't make any predictions about commodity prices.

Primary commodity prices are driven by many factors - supply and demand, speculation, futures markets, supply shocks etc.

Anonymous said...

Commodity prices are set in world markets. Rising Commodity prices have a very little to do with domestic US monetary policy.

and most of gold's price could be explained through Chinese demand. Again, very little to do with the US.

David said...

Commodity prices are set in world markets.

Are you sure this is how you want to word this? Commodities are exchanged in world markets based on the subjective value scales of market actors. The prices are determined (not set - no one sets them) by those preferences (crudely called "demand") in relation to the supply of the commodities AND the supply of the currency.

Rising Commodity prices have a very little to do with domestic US monetary policy.

Clearly they do and clearly they would be impacted worldwide if the supply of the world's reserve currency was being increased.

Do you wish to reconsider your statements?

rashid1891 said...

The Orlonater has it right. Krugman's rantings are really nothing more than National Socialism Philosophy 101. His rantings really have nothing to do with economics at all:

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