Friday, October 31, 2008

The revival of Keynesian economics with a special Krugman twist

Here's a glimpse at our future, via the economic thought of the man who will undoubtedly have a huge influence on American economic policy over the next four years: Paul Krugman [quotes from the New York Times via Independent Political Report].

Krugman notes that consumers have finally pulled back on spending:

So this looks like the beginning of a very big change in consumer behavior. And it couldn’t have come at a worse time.

It’s true that American consumers have long been living beyond their means. In the mid-1980s Americans saved about 10 percent of their income. Lately, however, the savings rate has generally been below 2 percent — sometimes it has even been negative — and consumer debt has risen to 98 percent of G.D.P., twice its level a quarter-century ago.

Some economists told us not to worry because Americans were offsetting their growing debt with the ever-rising values of their homes and stock portfolios. Somehow, though, we’re not hearing that argument much lately.

Sooner or later, then, consumers were going to have to pull in their belts. But the timing of the new sobriety is deeply unfortunate. One is tempted to echo St. Augustine’s plea: “Grant me chastity and continence, but not yet.” For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap — a situation in which the Federal Reserve has lost its grip on the economy.

Some background: one of the high points of the semester, if you’re a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone’s income.

So, to get this straight, Krugman's argument is that we built the current American economy by going deeply into debt as individuals in order to drive consumer spending to drive up productivity, and now that we're so deeply in debt that many of us have cut spending to pay our debts and begin saving ... we're the ones who are about to ruin the economy.

Individual virtue can be public vice.

Great concept that, and an indication of the extent to which we've gone down the path toward placing the "needs" of the State ahead of what's good for the citizens of that State.

You can tell by what Krugman prescribes to keep us out of a long recession:

The capitulation of the American consumer, then, is coming at a particularly bad time. But it’s no use whining. What we need is a policy response.

The ongoing efforts to bail out the financial system, even if they work, won’t do more than slightly mitigate the problem. Maybe some consumers will be able to keep their credit cards, but as we’ve seen, Americans were overextended even before banks started cutting them off.

No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend.

Let’s hope, then, that Congress gets to work on a package to rescue the economy as soon as the election is behind us. And let’s also hope that the lame-duck Bush administration doesn’t get in the way.

Unpack this just a little. Krugman is saying that save ourselves from a recession or depression that might last 4-5 years, our government [which is already $11 trillion in debt and falling further behind every day] should borrow or print more money and try to spend our way to prosperity.

The question for the good Dr Krugman would then be: when do we ever actually reduce or pay that debt, while dealing with the eventual financial debacles of out-of-control Social Security or Medicare spending? Exactly how much additional debt do we pile up for our children and grandchildren to pay when the interest payments on the natio exceed 50% of our tax revenues.

This Keynesian approach of deficit spending to fund government stimulus is only (even barely) justifiable in economic terms when there is a reasonable expectation that later economic growth will allow the accumulated debt to be effectively reduced to a smaller segment of the economy.

Given the specter of global warming, or the end of cheap oil, or a variety of other factors, that isn't even a vaguely responsible projection.

Think about it this way: Dr Kurgman and his followers can be thought of as either (a) generals preparing the fight the last war [in this case, the Great Depression]; or (b) being in denial that their poor spending habits have gotten them into this situation and that it will require different behaviors to get them out.

The bubble created by the Federal Reserve, deficit spending, and just all-out greed on too many parts is going to collapse. It's going to hurt, and the longer we avoid dealing with it realistically in an attempt to postpone that pain, the worse it will be.

Robert Heinlein had a saying that covers this: Never put off a trip to the dentist.

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