Thursday, April 18, 2013

Krugman: We Need a Debt Fairy to Accompany the Inflation Fairy

Paul Krugman has become the master of picking up the stray phrase and claiming that it is standard policy. The Wall Street Journal, for example, years ago used "bond vigilantes" in an editorial warning about taking on more debt, and now Krugman wants us to think that every editorial in the WSJ repeats the same error.

Someone in the Austrian camp said that large-scale inflation could be in our future, so now every Austrian is predicting hyperinflation all of the time. And since we don't have hyperinflation, why then every aspect of Austrian Economics must be totally wrong.

Today, Krugman is claiming that an error in an influential paper written by Carmen Reinhart and Kenneth Rogoff of Harvard is responsible for "destroy(ing) the economies of the Western world." According to the paper, if a government's debt exceeds 90 percent of a nation's GDP, then economic growth will tail off "sharply." However, some researchers looking at the data have concluded that the paper's methodology was fatally flawed and that there was no real 90 percent threshold, although higher levels of debt did correlate with lower growth rates.

According to Krugman, this paper was the deciding factor in "austerity" plans for governments in the West, and since "austerity" is bad, the paper played an important role in economic destruction. However, there is only one problem with that thesis: Krugman's commentary itself undercuts the paper's influence. He writes:
For the truth is that Reinhart-Rogoff faced substantial criticism from the start, and the controversy grew over time. As soon as the paper was released, many economists pointed out that a negative correlation between debt and economic performance need not mean that high debt causes low growth. It could just as easily be the other way around, with poor economic performance leading to high debt. Indeed, that’s obviously the case for Japan, which went deep into debt only after its growth collapsed in the early 1990s.

Over time, another problem emerged: Other researchers, using seemingly comparable data on debt and growth, couldn’t replicate the Reinhart-Rogoff results. They typically found some correlation between high debt and slow growth — but nothing that looked like a tipping point at 90 percent or, indeed, any particular level of debt.
OK, here is the problem. If economists from the start doubted its accuracy, then how can one also say that this paper -- THIS paper -- had such a powerful impact that most of the political leaders of the western world fully embraced everything these economists claimed and then designed their economic plans accordingly. This just does not make sense.

The U.S. Government continues to borrow at an astounding rate, Japan is openly attempting to print jillions of yen, and the European Central Bank and the Federal Reserve System are flooding the world with euros and dollars. Furthermore, as Bob Murphy already has pointed out, the only thing Krugman and other Keynesians deem to be acceptable as economic recovery is another boom, yet it was the unsustainable boom that got us into trouble in the first place.

Does Krugman think that this time governments will be better able to manage future financial bubbles or that booms won't run aground if Krugmanites are calling the shots? Somehow, I doubt seriously that another unsustainable boom is the answer.

So, we have Krugman claiming that what the world economies needed was more debt and, thus, also more printing of money. To put it another way, what Paul Krugman is claiming is that an Inflation Fairy is not enough. No, we also need a visit from the friendly Debt Fairy.


Salamano said...

Don't forget the "expectations" fairy...

...haven’t I been arguing that monetary policy is ineffective in a liquidity trap? The brief answer is that current policy is ineffective, but that you can still get traction if you can change investors’ beliefs about expected future monetary policy – which was the moral of my original Japan paper, lo these 15 years ago.

William L. Anderson said...

That is good! So, I guess that Krugman's Confidence Fairy will sprinkle true fairy dust upon our economy.

Dinero said...

>William Anderson . Have you got a comment on Paul Kugman's negative interest rate idea.

With a negative interest rate a buisiness would buy an asset and then the market price of the asset would increase more than the cost of the borrowing made to purchase it, but only because of inflation. This would give the appearance that that buisiness' activity has utility but it would be illusionary.

What do you think.

Dinero said...

- Correction - just to makre it clear thats my take on it not what he has said of course.

Bob Roddis said...

This is such convincing evidence of why we need more government debt:

[C]ontrary to RR, average GDP growth at public debt/GDP ratios over 90 percent is not dramatically different than when debt/GDP ratios are lower

"Does High Public Debt Consistently Stifle Economic Growth? A Critique of Reinhart and Rogo"

Thomas Herndon, Michael Ash, Robert Pollin - April 15, 2013

Bob Roddis said...

In a comment to a blog post by Justin Fox on the Heardon/Ash/Pollin paper, writes:

"Well, right now the evidence would seem to support it: The U.S. is muddling through, while austerity measures have pushed Europe back into recession and most of Southern Europe into depression."

Not to advocate austerity (on the contrary) but this is something of a misconception. General government spending has barely changed in the eurozone, falling from 51.2% to 49.3% as a percent of GDP from 2009 to 2012 whereas in the US it has undergone a much larger contraction falling from 44.2% to 40.6% of GDP over the same time period. (Via the IMF database.)

Fiscal austerity has only been practiced in earnest in Greece, Ireland, Portugal and Spain. Take a look at Figure 15 for example:
Other than the countries named above, only Slovakia has cut spending in discretionary terms more than than the US between 2009 and 2012 and only the Netherlands and Belgium have increased taxes in discretionary terms more. And Belgium, Finland and the Netherlands have not cut spending at all, and Finland, Germany and Slovakia have actually cut taxes.
So far, only five countries (out of 17) in the eurozone have not had a second or third recession since 2008: Austria, Estonia, Finland, Germany and Slovakia. But the real GDP of Austria, Finland and Germany contracted in 2012Q4, and based on the PMIs from the first three months of the year, Austria and Germany are very likely in a second recession (I can only guess about Finland).

I believe the key to understanding why economic performance throughout the eurozone is so bad compared to the US, despite the US having actually done more fiscal austerity in aggregate, is monetary policy. For example, the ECB’s balance sheet only increased from 1.46 trillion euro in September 2008 to 2.65 trillion euro currently (about an 80% increase) whereas the Fed’s balance sheet has increased from $930 billion to $3.23 trillion over the same period (about a 250% increase). (Via the ECB and the Fed.)

The US has done both far more fiscal austerity and far more QE than the eurozone.

It is a purposeful butchering of the English language to refer to 44.2% to 40.6% of GDP and 51.2% to 49.3% of GDP as “austerity”.

Edward said...

"yet it was the unsustainable boom that got us into trouble in the first place."

(Sigh) do the austrians have an indicator where they can tell ex ante that a boom is "artificial" and "unsustainable' if so, what is it? Government Debt? High Private debt relative to incomes? If not are we to take the mindless asssertions of "unsustainable" on faith?

William L. Anderson said...

Well, I think we safely can say that the last boom was "unsustainable." Austrians do hold that if a boom is stimulated by loose credit, then it will run aground in the future.

No, we cannot pinpoint the exact second when the boom runs aground.

Unknown said...

I thought it was that Krugman and his followers were using inflation as the guide for the correct debt level. No inflation means we need to borrow more. It simply reinforce an oppinion of future prosperity without making any hard choices right now- just print more money. Of course this will be acceptable to whatever party owns the white house at the time. No emprical evidence needed - it's a political orgy of free spending programs for everyone

Edward said...

"Well, I think we safely can say that the last boom was "unsustainable.""

Can we? It would seem that hindsight helps a lot there Professor. :-)

"Austrians do hold that if a boom is stimulated by loose credit, then it will run aground in the future.
"loose" and "tight" are relative terms. What Austrians think of as easy money, others think of as pathetically inadequate or even tight.

"No, we cannot pinpoint the exact second when the boom runs aground."

No one can. I thinbk you misunderstood what I was trying to say. No one can pinpoint "the exact second" as it were. But is there an useful predictive indicator that you can watch during the boom that gives you a roough idea that the boom is false, and that it will end in ROUGHLY that amount of time?

William L. Anderson said...

Mark Thornton was on the record in 2004 with his article, "Housing: Too Good to be True."

In 2006, while appealing a tax ruling on my house, I told the assessment board then that the current boom was unsustainable and specifically told them not to make future budget plans based on what they saw at the present. (They told me that I was wrong, and one remarked, "I don't see that happening.") And, yes, I had witnesses.

In 2006 we have Peter Schiff's famous confrontation with Arthur Laffer on what was to come.

So, I think Austrians did pretty well in that regard. Our emphasis was that it was not sustainable.

Bob Roddis said...

(Sigh) do the austrians have an indicator where they can tell ex ante that a boom is "artificial" and "unsustainable'

Anything purchased with a loan of funny money created out of nothing has been artificially bid up higher than it otherwise would have been. A normal person should be appalled ab initio at the unnatural benefit handed the borrower and the artificial price of the sale. Subsequently, when you see formerly $150,000 homes selling for $500,000 in funny money loans, it's a good bet that the process is unsustainable unless people actually have $500,000 worth of real goods and services to trade for such a house and are not seeking an "inflation hedge".

Dennis said...

Seeing people flipping houses at the rate they were prior to 2008 and otherwise treating home equity like an ATM is a pretty darn good sign of a bubble. No good outcome is possible from this kind of activity.

Bob Roddis said...

Seeing people flipping houses at the rate they were prior to 2008 and otherwise treating home equity like an ATM is a pretty darn good sign of a bubble. No good outcome is possible from this kind of activity.

"Sigh" or "Duh"

Edward said...

"funny money"

A loaded term bob

Bob Roddis said...

Edward said...
"funny money" A loaded term bob

Oh my. So unlike terms such as "austerity" and "stimulus".

Edward said...

Well, at least "austerity" and "stimulus" tell you something abou the worldview of the people they are being used by. What would be normal money to you, Bob? Free market money, gold? Bitcoin?

Bob Roddis said...

Real "austerity" in the sense of massive tax and spending cuts leads to prosperity, fancy clothes, hot cars and great food. Nothing "austere" about it.

Keynesian "stimulus" leads to permanent depression, misuse of resources and perpetual pricing distortions.

Cato said...

Krugman doesn't take this seriously. He doesn't. At some point he got it in his head that

a) All history is revisionist history.
b) The "winner" is the most-believed revision.
c) If only a passionate advocate of the Good Revision would have the courage to take one of God's Children by the hand and say, "That stupid thing you believe? It's true!" why, then it might have a chance of becoming true.

This is why he makes things up out of his ass.
This is why the invective, the casting as evil his opponents, the charts of debt when the argument is spending, the definition of the Reagan years as beginning just after Nixon and ending just before Clinton, and all of his other Googlibly falsifiable claims. (e.g.,"There is no correlation between regulation and unemployment.")

This is not a man concerned with facts. This is a man concerned with keeping the congregants marching onward, eyes down, hearts up, and self-righteous in the lamest set of beliefs this side of ConfederateFlagVille, AR.

Anonymous said...

Frightening. Krugman's intellectual honest has flown out the window completely when you mentioned "The Debt Fairy." He'll then either retire from NYT and have his own business show at MSNBC or end up writing for The Economist, another propaganda rag that endorsed Obama twice!

Anonymous said...

Intellectual honesty flew out the window.

There. Fixed.

John Dunham said...

I'm still trying to figure out why anyone would consider an economics paper to be influential

Anonymous said...

John, Krugman also wrote something about Austrian economics being highly influential in the GOP. He's clearly out of touch with reality on top of being a political operative as Professor Anderson has been saying all along.

Forrest said...

Okay, so what happened was that prices of a commodity become over valued. That Commodity ( whatever it is ) is not worth as much as what everyone believes it is ( typically stocks, but could be gold, silver, bitcoin, etc ) in the last case housing and the over leveraging and packaging or mortgage backed securities.

What occurs is a drop in value, people lose money, typically the price over corrects to be undervalued, repeat with next fad...

Now the difference between Keynesian ( I actually doubt Keynes would approve of Krugman ) and Austrian philosophy on this issue is the Austrian see this as a short term correction to be born out, the Keynesian attempts to 'fix it'.

TO me both sides are 'correct' as in the market WILL revive under either strategy.

As for Austerity, (sigh) I agree with correcting a budget so that you are not deficit spending in times of plenty and by the same token you have a little wiggle room when times are bad to borrow. But this is very different from the inflationary pressures that we have seen from the Keynesian side of the argument.

In the case of Greece and Spain, they are BAD DEBTORS they MUST enter austerity in order to obtain continued bank loans. Here is perhaps a better question for Krugman. Why would Austerity be a bad thing if the Government were not such a large portion of GDP in the first place?

Another problem with comparing nations and economies is that the USA is huge...We are number three and by far the most diverse population. One of Krugman's favorite countries to talk about is Sweden. A country that is the same population of North Carolina... It is easy to create economic policies in a country the size of a medium state... Heck Even Canada has fewer people than California... California's GDP is what 1.9 Trillion? Canada's is $1.74?

It is just difficult to compare and contrast nations that VARY SO MUCH. In culture and even economic conditions. I would also suggest that the reason they have as high a GDP in dollars versus the USA is because we have been devaluing our currency for the past decade.

Look when Government is 40% of your economy it is going to hurt and slow down your economy to drop it. Half of the Greek Economy was Government Spending in 2008. Now it is 46.8%. Should you see a drop in the velocity of money when this occurs. YES!!! an Emphatic YES!!! You just dropped almost 4% off your Velocity of money. It should hurt like CRAZY. But why in the world would you allow Government Spending to get to that portion of your economy in the first place?

Sorry... I am ranting now...

Anonymous said...

Why does the fairy dust have to be spread around evenly to all? Why not have it spent specifically on things essential to the long-term health of the economy, like infrastructure, R&D and training? I certainly don't see the private sector biting at the bit to do that. How much has research into physics benefitted the economy, and how much of that was/is paid for with private funds? More normally, the private sector whines about needing things like better roads and better trained workers so it can be more competetive. Of course, it want government to build the roads and training centers. Have your cake and eat it too! The biggest hypocrites are those who feign objectiveness only to state subjective "truths".

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