Monday, February 27, 2012

Will inflation save the European economy?

In his latest column, Paul Krugman believes that he has the answer to saving the European economy from disaster. The solution? In a word, inflation. Yes, if the European Central Bank will show the "courage" to print more money, everything will be fine.

I admit that at one level, Krugman is correct when he writes:
So what does ail Europe? The truth is that the story is mostly monetary. By introducing a single currency without the institutions needed to make that currency work, Europe effectively reinvented the defects of the gold standard — defects that played a major role in causing and perpetuating the Great Depression.

More specifically, the creation of the euro fostered a false sense of security among private investors, unleashing huge, unsustainable flows of capital into nations all around Europe’s periphery. As a consequence of these inflows, costs and prices rose, manufacturing became uncompetitive, and nations that had roughly balanced trade in 1999 began running large trade deficits instead. Then the music stopped.
Note that Krugman does not think that countries like Greece have been irresponsible, or at least he indicates such in this column. Instead, he seems to believe that another round of inflation would pretty much solve everything.

Krugman is correct when he says that the single currency of the euro did impose some requirements, although like a typical Keynesian, he believes that any fiscal discipline really is a bad thing, given that all wealth creation begins with government spending. When Europe went to the euro, it meant that when governments like that of Greece borrowed from European banks, they would have to generate the revenues via taxation to pay back the loans.

Obviously, that would restrict the Greek government's behavior, given that it could not print euros, and borrowing would have to be done at a sustainable rate. Unfortunately, given the fact that Greece, like many other small European countries, has a bloated public sector that is controlled by militant labor unions, it was inevitable that the Greeks sooner or later would borrow well beyond any threshold to pay back the loans, given that fiscal discipline does not exist with the Greek government.

Unfortunately, Krugman believes that fiscal discipline is bad, bad, bad, and that inflation is a much better "solution" to any problem that the Law of Opportunity Cost might pose when governments spend themselves into a corner. (Don't forget that in his book, The Return of Depression Economics, Krugman declares that literally printing money creates a "free lunch" -- his words.) He writes:
If the peripheral nations still had their own currencies, they could and would use devaluation to quickly restore competitiveness. But they don’t, which means that they are in for a long period of mass unemployment and slow, grinding deflation. Their debt crises are mainly a byproduct of this sad prospect, because depressed economies lead to budget deficits and deflation magnifies the burden of debt.
That might be true, although Krugman forgets that if Greece still were on the drachma, then the banks might have been more reluctant to lend to that government -- although the prospect of being backstopped by the European Central Bank might have been enough to encourage the banks to lend even when they figured being paid back in euros was a stretch. Even so, if the loans had been in euros and Greece were on the drachma, then Greece still would have had the same issues, given that the banks would not have been willing to accept drachmas in repayment.

By being on the euro and with the liberal lending policies by banks, the Greeks were getting a free ride, and they knew it and believed that they were entitled to it. This is something Krugman never addresses because (1) the inevitable outcome would fall into the Opportunity Cost category, and all good Keynesians know that printing money trumps laws of economics, and (2) government spending CREATES wealth and the more government spends, the better off we are.

Likewise, when Krugman has called for the U.S. Government to borrow money and then give it to state governments, he claims that such actions would "stimulate" the economy and foster economic recovery. When California's government employee unions take an ever-growing bite of the Golden State's revenues and overall economy, Krugman refuses to see this situation as the unions plundering everyone else. Instead, he seems to believe that the unions are the responsible actors, and anyone who thinks otherwise is evil.

Keynesian theory literally turns economics on its head. Spending and printing money create wealth; wealth creation through saving, capital formation, and judicious choices by consumers and investors creates depressions and should be stopped by government, which should use force, if necessary, to keep people from acting responsibly.

21 comments:

Lord Keynes said...

"In his latest column, Paul Krugman believes that he has the answer to saving the European economy from disaster. The solution? In a word, inflation."

A ridiculous and contemptible caricature. Krugman nowhere says his solution is price inflation or monetary inflation. His solution is a proper level of aggregate demand - i.e, fiscal policy - to stimulate higher levels of output and employment, as idle resources and unemployed workers are put to work.

"Note that Krugman does not think that countries like Greece have been irresponsible,"

You clearly didn't read the article properly:

"Next up, the German story, which is that it’s all about fiscal irresponsibility. This story seems to fit Greece, but nobody else."
------

"Keynesian theory literally turns economics on its head. Spending and printing money create wealth"

Spending and addition of reserves to a money supply are different from private sector wealth creation. Additional spending creates the demand that stimulates investment and further employment. just as, for example, wholly private sector spending would stimulate investment and further employment.

Your feeble caricatures are a joke.

Anonymous said...

By being on the euro and with the liberal lending policies by banks, the Greeks were getting a free ride, and they knew it and believed that they were entitled to it. This is something Krugman never addresses

But he DOES and you have even quoted him:

More specifically, the creation of the euro fostered a false sense of security among private investors, unleashing huge, unsustainable flows of capital into nations all around Europe’s periphery. As a consequence of these inflows, costs and prices rose, manufacturing became uncompetitive, and nations that had roughly balanced trade in 1999 began running large trade deficits instead. Then the music stopped.

What are we supposed to think? You don't read your own posts?

Mikaelus said...

Spending and addition of reserves to a money supply are different from private sector wealth creation. Additional spending creates the demand that stimulates investment and further employment. just as, for example, wholly private sector spending would stimulate investment and further employment.

But such spending must, inherently, be funded through additional taxation(or deficit spending ,which has only served to exacerbate our current problems, but which must, hopefully, be financed by higher taxation down the road), which requires the transfer of money away from the private sector in this form. The problem with this is that government central planners tend to lack the "great wisdom" which Keynesians(and other central planning proponents) attribute to them, and such money is often spent by these planners on the basis of political connection(such as the Green energy debacle with Solyndra) rather than on the basis of analyzed merit or true economic benefit.

If we had, say, 1000 people spending $5, variance in the receivers of that money would be larger than if we had a 5 person committee planning together to spend $5000. Market forces would work to demonstrate that the example with a larger number of people would lead to a greater level of economic growth as a smaller % of the money would be likely to go towards "malinvestments", while the money spent by the committee could likely all go towards malinvestments, especially if those 5 people were all appointed by one or two folks who have campaign contributors on the list of firms that could potentially receive money from this committee.

I do not mean to imply, of course, that all firms who contribute to campaigns are incapable of succeeding in the market on their own, only that such a scenario distorts market forces, as relying on a smaller number of people to make market choices inherently increases the effects of bias rather than mitigating them, especially when that bias is related to the nature of their continued employment.

William L. Anderson said...

Krugman refuses to outright acknowledge that the Greek public sector was bloated and the unions were being paid for essentially not working. Likewise, Krugman believes that we should be bailing out the public sector unions in the other states.

Notice that Krugman, whether in his Playboy interview or in his columns, believes that high wages will help spur on the economy. He refuses to see that high wages are the RESULT of a productive economy, not the other way around.

Yes, I do read my posts, and I also read between the lines.

William L. Anderson said...

I'm going to be gone the rest of the day and won't be back on the computer until tonight, so it will take a while to process your comments. Sorry for the delay, but I have to take care of family business.

Desolation Jones said...

"Krugman nowhere says his solution is price inflation or monetary inflation. His solution is a proper level of aggregate demand"

Lord Keynes, I disagree. He's a New Keynsian, not an MMTer. Obviously implicitly he does want a proper level of AD, but he does think it can be achieved through monetary inflation. When he says "and accepting higher inflation" he's talking about the central bank setting a higher inflation target.

Major_Freedom said...

LK:

A ridiculous and contemptible caricature. Krugman nowhere says his solution is price inflation or monetary inflation. His solution is a proper level of aggregate demand - i.e, fiscal policy - to stimulate higher levels of output and employment, as idle resources and unemployed workers are put to work.

That's just a stupid, uninformed, contemptibly evasive way of saying the exact same thing: inflation.

First, the state does not and cannot know the "proper" level of aggregate demand, second, fiscal policy cannot increase aggregate demand unless it is monetized, i.e. unless there is monetary inflation, i.e. unless there is what Anderson correctly attributed to Krugman: inflation. To say that there should be a "proper" level of aggregate demand, is to say there should be inflation.

Spending and addition of reserves to a money supply are different from private sector wealth creation.

The Keynesian believes inflation generates wealth.

Additional spending creates the demand that stimulates investment and further employment.

False. The only thing that stimulates employment is saving and investment, which the government does not do.

Major_Freedom said...

LK:

Krugman wrote:

"If the peripheral nations still had their own currencies, they could and would use devaluation to quickly restore competitiveness. But they don’t, which means that they are in for a long period of mass unemployment and slow, grinding deflation."

You are incredibly ignorant for suggesting that Krugman didn't say the solution is inflation. That right there is a call for inflation as the solution.

Do you not even understand what "devaluation" means? I knew you were ignorant, but this is just sad.

macroman said...

Prof Anderson, I didn't see in the quotes you gave Krugman saying "free lunch". Where exactly did he say that? Somewhere in "Depression economics"?

Tel said...

http://www.pkarchive.org/theory/LoveInflation.html

"This brings us to the deepest sense in which depression economics has returned. The quintessential economic sentence is supposed to be 'There is no free lunch'; it says that there are limited resources; to have more of one thing you must accept less of another. Depression economics, however, is the study of situations where there is a free lunch, if we can figure out how to get our hands on it, because there are unemployed resources that could be put to work.

In 1930, John Maynard Keynes wrote that 'we have involved ourselves in a colossal muddle, having blundered in the control of a delicate machine, the working of which we do not understand'. The true scarcity in his world - and ours - was therefore not of resources, or even virtue, but understanding."



Indeed, it was Mises and Hayek who explained why information and economic calculation has a value and why this value cannot be obtained by central planning. I agree that the scarcity is understanding, therefore the people who can demonstrate ability in understanding (i.e. leadership) should be entitled to the rewards they are able to achieve by using this information.

Woody said...

If inflation saves an economy, don't counterfeiters do the same?

macroman said...

The central point is whether there are unemployed resources in a depression. Only then, says Krugman, is there a free lunch. Nearly everybody outside this blog thinks there are unemployed resources in a recession.

And of course the lunch does not appear magically. The previously unemployed resources produced it. You all accept that private people could put these resources to work and at least break even - its possible.

If private savings are way more than demand for private investment, the government can do what everybody outside this blog accepts they do well, build roads for example, and it can do it very cheaply, and lessen the social problems and costs associated with long term unemployment.

macroman said...

MF. Krugman believes one can have a devaluation without domestic inflation if there are idle resources. International economics is his specialty and it might be worth considering his view on that before jumping to conclusions. He gives examples of countries that have recovered by devaluation, without inflation matching the devaluation. See The Accidental Theorist.

Bala said...

"International economics is his specialty"

Now it figures. Krugman is not an economist because he specialises in "international economics". Good observation.

Anonymous said...

"Did I mention that Sweden, which still has a very generous welfare state, is currently a star performer, with economic growth faster than that of any other wealthy nation?"

The Swedish Austrians must be a very lonely bunch!

Major_Freedom said...

macroman:

MF. Krugman believes one can have a devaluation without domestic inflation if there are idle resources.

macroman, printing money IS inflation.

What you are talking about is inflation defined by rising prices. This is a definition that leads to confusion because it doesn't address the reason WHY prices are rising.

At any rate, it's false that prices won't rise higher than they would have otherwise been if there are "idle resources." Printing money does not just affect idle resources. It affects non-idle resources as well, since when money is printed, people don't just spend the new money on idle resources only.

Furthermore, Krugman et al have no clue as to why resources are idle. They view all resources as homogeneous, and if some resources are idle, then the government should print and spend money to get them "moving" again, despite the fact that the highest valued use of the resource is temporarily idle as the best use is contemplated by the owner.

Besides, if the opportunity costs for printing and spending money on idle resources is zero, then why aren't the owners selling those resources for just above zero price?

International economics is his specialty and it might be worth considering his view on that before jumping to conclusions.

Stop fawning. I am fully aware of Krugman's economic days. He's no longer an economist.

He gives examples of countries that have recovered by devaluation, without inflation matching the devaluation. See The Accidental Theorist.

See Robert Murphy's smackdown.

Anthony Lima said...

Except you either have to tax people first or devalue their currency.

macroman said...

MF: macroman, printing money IS inflation.

What you are talking about is inflation defined by rising prices. This is a definition that leads to confusion because it doesn't address the reason WHY prices are rising.


MF, you once asked me for examples of verbiage and scholasticism. This is a perfect example. You know perfectly well what I meant because you even say what I meant.

But you can't help trying to make a point by using your private Austrian definition that inflation means "inflation of the money supply" rather than the general usage "inflation of prices".

Yes MF, I 100% agree that if inflation means increase in the money supply, then the Fed by increasing the money supply is causing inflation. Great tautological "insight" into the workings of the economy, which says absolutely nothing about any connection between prices and money.

Major_Freedom said...

macroman:

MF, you once asked me for examples of verbiage and scholasticism. This is a perfect example. You know perfectly well what I meant because you even say what I meant.

But that is not what Anderson meant. You responded to Anderson's point as if Anderson meant "rising prices."

You are supposed to know what people mean before you reply to them, and I was correcting you without making that point explicit.

But you can't help trying to make a point by using your private Austrian definition that inflation means "inflation of the money supply" rather than the general usage "inflation of prices".

It's the definition Anderson used, and you replied using a different meaning.

Yes MF, I 100% agree that if inflation means increase in the money supply, then the Fed by increasing the money supply is causing inflation. Great tautological "insight" into the workings of the economy, which says absolutely nothing about any connection between prices and money.

First, neither Anderson nor myself said that "the Fed by printing money is causing inflation." That would AGAIN be YOUR definition of inflation.

Second, it's the exact opposite. It is precisely defining inflation as rising prices only that masks the actual workings of what CAUSES rising prices, namely, the cause is inflation of the money supply.

Inflation as an increase in the money supply is the original meaning of inflation before Keynesians and Monetarists hijacked the word and changed the definition to suit their agenda of wanting to print money and then telling people "there is no inflation people!" as long as prices aren't nominally rising from one period to the next, despite the fact that their real wages are declining.

Did you know that real wages have been stagnating since the early 1970s, when the US left the last vestiges of the gold standard?

It's not a coincidence.

Anonymous said...

Now, the E.U. proposes a “hair of the dog” solution for Greece. It is asked to commit financial suicide by raising taxes, reducing spending and borrowing even more money, the very thing that got it into trouble. Meanwhile, the other E.U. nations will commit suicide along with Greece, by lending it precious money they can’t spare.

The solution for the U.S states is clear: Federal creation and input of money. The federal government has this power, in fact, gave itself this power specifically to prevent American bankruptcies, and has used this power many times, most recently to end the recent recession.

The solution for the E.U. states is equally clear, and that solution is not loans from wealthier E.U. nations to poorer E.U. nations. The solution is for the E.U. to function just like the U.S. Fed. Create money and supply it to the E.U. states. Until then, the E.U. will live in a dream world, or rather a nightmare world of ongoing financial desperation.

More than 200 years ago, the U.S. was a group of independent nations, each with individual mores and beliefs. Yet for mutual survival, they had the good sense to ignore their differences and come together under one rule. The EU should do the same.

Aniruddha said...

The current problem with EU is a structural problem but surely there are monetary solutions to it. One, the sad part about the Austrian Economics story is that despite their prophecies and dire predictions, there is no inflation in the Eurozone or in the USA. Printing up more money would add liquidity to the Eurozone's troubled financial sector, thereby stimulating investment. Moreover, government can borrow at a cheaper rate and spend in the economy to boost aggregate demand. All this would mean a little inflation, but that's a price worth paying for.

On the contrary, austerity at the present stage would only exacerbate the problems. I do agree with the austerity camp that eventually fiscal imbalances must be addressed. The best to way to reduce the debt for many countries is actually monetary stimulus today. Paul Krugman in accidental theorist gives an example of the babysitting economy in recession because couples do not spend on babysitting in uncertain times. And to increase their reserves, they stop spending and rely on other people's spending. While it is a perfectly rational thing for an individual to save when the economy's in a recession, for the economy it is a disaster. Because, everybody saves there isn't enough economic activity in the economy. If the government too decides to remain austere, it will make the problems much worse. On the contrary, if there is a monetary stimulus, people have more money to spend than before and hence there is a big boost to the Aggregate demand which leads to higher tax revenue which can then be used to pay back the debt.

Think of it this way. When you're sick and poor, what do you address first your health or your wealth? If you pay for your health, i.e. pay to keep the economy out of recession, eventually you will become healthy to pay back the debts you accumulate when you were sick. To say that i need to be fiscally responsible when I'm sick and hence to postpone treatment would make me more sick and less financially stable in the long run. The answer is astonishingly simple, PRINT MORE MONEY so that the economy gets back on track and eventually a high GDP would translate to high tax revenue and you can pay back your debts with a devalued currency!