Thursday, June 23, 2011

Focusing on Krugman

In Woodford on Monetary and Fiscal Policy Paul Krugman reviews the thoughts of Mike Woodford on "policy options when you’re up against the zero lower bound".

Then PK describes what he himself

was thinking in, say, January 2009. With the severe financial crisis still relatively recent, and many people still expecting a V-shaped recovery, it didn’t seem possible to persuade the Fed to commit to a permanent rise in the monetary base or a rise in the medium-run inflation target, nor did it seem possible to convince markets that there had been a long-run change in policy. The chances for persuading Congress to agree to a large temporary fiscal stimulus seemed much better.

But as it turned out, that didn’t happen either...

I do think it's funny that PK spends so much time worrying about the chances for persuading Congress and the possibility of persuading the Fed what they should do. Perhaps Krugman would be more persuasive if rather than worrying what others think, he would focus on writing persuasive arguments about what must be done.

Just to be clear, the options Paul Krugman sees are
1. increase the monetary base and/or increase inflation; and
2. increase government spending with "a large temporary fiscal stimulus".

Now if I tell ya I'm gonna disagree with Krugman, you're prob'ly gonna think I'm austerian. I'm not. But I have to evaluate Krugman's options in relation to the problem as Krugman defines it.

As Krugman defines it

In Default Is In Our Stars (25 September 2010), Krugman wrote:

I think it’s fair to say that a majority of economists believe that excessive private debt played a key role in getting us into this economic mess, and is playing a key role in preventing us from getting out.

Eh, slightly out of focus, there. He doesn't say what he thinks. He says what he thinks "a majority of economists" think. Is he trying to strengthen his position by embedding himself in the majority? Can't say. Does he include himself among them? Doesn't say.

Well then, here's another. Krugman of 18 November introduces his new 32-page PDF, Debt, Deleveraging, and the Liquidity Trap, and offers an informal summary of the paper as well. In the summary, Krugman writes:

Sharply rising debt, it’s widely argued, set the stage for the crisis, and the overhang of debt continues to act as a drag on recovery.

Heh. Same thing again. Doesn't say what he thinks. Says what is "widely argued".

Let me try one more time. In the recent Mr. Keynes and the moderns, Krugman writes

I constantly encounter the argument that our crisis was brought on by too much debt – which is largely my view as well...

"Largely". Well, I guess that's as good a commitment as we're gonna get from Paul Krugman. So I guess I'll go ahead and say what I think Krugman thinks, as he seems unwilling or unable to do so. I'll take a chance and say Krugman includes himself among those arguing widely that debt is the problem. Krugman includes himself in that "majority" of economists who see excessive debt as the problem. Krugman includes himself among those who think the crisis was brought on by "too much debt".

Too much debt

So, assuming that Krugman sees excessive debt as the problem, let us evaluate his solutions.

His first option is to have the Federal Reserve increase the quantity of base money. Does this solve the problem? It could. It could reduce the debt-per-dollar ratio, which is exactly what needs to be done. But the method is indirect at best. Directly, it affects only prices, not debt.

Moreover, in practice, a large fall in debt-relative-to-base-money has induced only a small decline in debt-relative-to-M1-money, which is the crucial ratio.

His second option calls for a massive increase in government spending and -- presumably, though this also is out of focus -- a massive increase in the federal debt. But the problem, according to Krugman (sez I) is that there is too much debt already.

Indeed, yes, Krugman's words are "excessive private debt". The federal debt is not private. But option two increases debt. It does not reduce debt. And if the problem is excessive debt, the solution is to reduce debt.

Neither of Krugman's options reduces debt. Specifically, neither of Krugman's options reduce private-sector debt. Furthermore, if either of Krugman's options does work, the outcome will be renewed economic growth, doubtless accompanied by more private-sector debt growth. Yet excessive private-sector debt was the problem to begin with.
But as long as excessive private-sector debt remains an unresolved problem, there is no chance that Krugman's options can succeed.
Perhaps if Paul Krugman could focus on the problem -- if he could actually bring himself to say that he thinks excessive private debt played a key role in getting us into this economic mess, and a key role in preventing us from getting out -- perhaps then he would have a better handle on a solution.

A better handle on a solution

I would print money and use it to pay off debt. Destroy that money by destroying debt.


nanute said...

nanute said...

Krguman says the problem was caused by too much debt. What kind of debt? He doesn't say. You say "I'd print money to pay off debt." In a round about way that is kind of what QE1 did. Except that the underlying risk associated with that debt still exists, and remains a drag on the economy. I'd print money and pay off consumer debt. I'd also like to see some of the fraudsters frog marched in the dock. Rewarding reckless behavior that has gotten us into this mess only prolongs the prospect for recovery. I understand the necessity for stabilizing the system. I don't understand lack of accountability and not paying for almost destroying the US economy.

The Arthurian said...

Hi, nanute.

You say "I'd print money to pay off debt." In a round about way that is kind of what QE1 did. Except that the underlying risk associated with that debt still exists, and remains a drag on the economy.

That's exactly right.

They created all that QE money, and with it they bought up "troubled assets" and got them out of the private sector.

But they ignored the troubled liabilities, the mortgages people were struggling to pay. They left the troubled liabilities in the economy, and that is why the economy remains troubled today.

It would have been so easy: Print that QE money and use it (for example) to make mortgage payments for people. As if by magic, the assets would have been no longer troubled. And the people that had their liabilities relieved would have the opportunity to spend some of their freed-up money and thereby help the economy recover.

It is, of course, essential to change the economic policies that encourage the excessive accumulation of debt. But recovery has to come first, I think.