Paul Krugman continues to ride his hobby:
From an economic point of view World War II was, above all, a burst of deficit-financed government spending, on a scale that would never have been approved otherwise. Over the course of the war the federal government borrowed an amount equal to roughly twice the value of G.D.P. in 1940 — the equivalent of roughly $30 trillion today.
Had anyone proposed spending even a fraction that much before the war, people would have said the same things they’re saying today. They would have warned about crushing debt and runaway inflation. They would also have said, rightly, that the Depression was in large part caused by excess debt — and then have declared that it was impossible to fix this problem by issuing even more debt.
But guess what? Deficit spending created an economic boom — and the boom laid the foundation for long-run prosperity. Overall debt in the economy — public plus private — actually fell as a percentage of G.D.P., thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts. And after the war, thanks to the improved financial position of the private sector, the economy was able to thrive without continuing deficits.
The economic moral is clear: when the economy is deeply depressed, the usual rules don’t apply. Austerity is self-defeating: when everyone tries to pay down debt at the same time, the result is depression and deflation, and debt problems grow even worse. And conversely, it is possible — indeed, necessary — for the nation as a whole to spend its way out of debt: a temporary surge of deficit spending, on a sufficient scale, can cure problems brought on by past excesses.
As I have said before I am not opposed in principle to fiscal stimulus via deficit spending. I’d be a lot more comfortable with Dr. Krugman’s prescription if it had more empirical support than it does, if there were reason to believe the (n+1)th dollar of deficit spending is no less effective than the nth (remember, with the exception of a handful of years we’ve been running massive deficits for decades), and if I had greater confidence that the actual programs that would be enacted for fiscal stimulus via deficit spending would actually increase aggregate demand rather than partly increasing aggregate demand but largely transferring income from one group of the top 5% of income earners to a different group of the same bracket.
To be completely honest I’ve got to admit that I’m finding the phrase “aggregate demand” increasingly irritating. I think that “increasing aggregate demand” is mostly just a euphemism for spending money on pet projects.
And as I’ve said before I’d like to hear Dr. Krugman’s ideas for paying off the debt he’s recommending that we incur. He’s not innumerate. Surely he recognizes that there’s no foreseeable level of economic growth that will allow us to pay off an additional $2 trillion in debt in the foreseeable future. Unlike the situation following WWII, ours won’t be the world’s only functioning industrial economy.
What level of increased taxes would be required to do so? How would that reduce future growth? What if growth in the medium term, say, five to ten years remains stubbornly below the level required for actual job creation? Keep spending?
Dave,
Posts like these are sure to boost the aggregate demand for your analysis on aggregate demand.
Sorry, couldn’t resist!
Overall debt in the economy — public plus private — actually fell as a percentage of G.D.P., thanks to economic growth and, yes, some inflation, which reduced the real value of outstanding debts.
Of course private debt fell during WWII – it was called rationing. I believe my mother may still have some of her ration coupons around the house somewhere.
Does Krugman think private citizens should all be strictly limited in what we can buy by force 0f arms until the crisis is over? Should we be forced to save? After all, that private money also helped spur that post-war economic burst. Or does he think all those savings happened in a vacuum?
I’ve held off on addressing the contents of Dr. Krugman’s column more directly. It has a number of deeply puzzling issues.
First, studies of government spending during WWII have demonstrated a very low multipliers. Dr. Krugman has condemned such studies as relevant only to the WWII period. Does he believe differently now? Doesn’t that mean he needs to accept the very low multiplier, too?
Second, GDP plummeted during WWII. It didn’t increase. I guess that means that I’m confused. As I understand the General Theory it doesn’t say that deficit spending in 1942 results in growth in 1946 but that seems to be what Dr. Krugman is saying.
Third, GDP was rising very sharply until the declaration of WWII and after the war and wage, price, and production controls were removed, it resumed its growth. In between it nearly collapsed. I take two things from that. 1) deficit spending isn’t necessary to explain the post-WWII growth. Reversion to trend will do it. 2) If the deficit spending is so stimulative shouldn’t GDP have gone up during the war?
Sometimes the most obvious explanations are the best.
Krugman’s good work is in the area of trade. And as I understand it, it actually is stellar work.
But in domestic economics, Keynesian/Monatarist etc. Not so much. He’s nothing more than a leftist shill. And having read some of his stuff the subject matter of which I’m very familiar with – a bald faced liar.
One of the complaints by economists in the Austrian school and those sympathetic to that school is that in macro-economics the economy is not a complex thing. All of those markets are treated as giant shapeless masses summarized by aggregate demand and supply. This kind of approach I think hides potential problems in the underlying economy.
For example, Dave has often noted we have over invested in markets like housing and finance. Further, policy has been to try and shore up both housing and finance. From a more micro economics stand point a (micro-)economists would argue that we have an over-supply in those two markets and prices need to come down and resources need to be shifted. But looking solely at aggregate demand and supply that kind of finer level of detail might be lost. The problems inherent in those policies is overlooked. In fact, increasing those policies might be seen as a good thing which from the (micro-)economists standpoint would merely push of the day of reckoning.
Just for those reasons alone I’d love to ban the terms aggregate demand and aggregate supply.
And you are also correct in that comparison’s to WWII are likely inappropriate. After WWII most of Europe was a smoldering heap. So was Russia and Japan. China and the rest of Asia was remarkably under-developed as were (and to some degree still are) South America and Africa. Today Japan, China, Korea, and Europe are all in fine shape…at least their major cities have not been carpet bombed.
Also, WWII was a period of reduced consumption and standards of living. You gave up many amenities and commodities for the war effort. When the war ended there was a considerable amount of pent up demand for consumer goods. Add those two things together and once you deal with the fighting men returning home and looking for jobs, you have a situation ripe for economic expansion. We sure as Hell don’t have that today. Today we have come off years of binging on consumer spending. That was what drove part of the bubble, IMO.
In other words, 2010 is not 1938 nor is it 1948. Krugman is a fool if he thinks otherwise.
TAXES DON’T FUND GOV’T SPENDING. THEY SERVE TO REGULATE AGGREGATE DEMAND. THE SAME GOES FOR BOND SALES. BOND SALES JUST HELP THE CB MAINTAIN THE OVERNIGHT INTEREST RATE. THERE IS A REASON KRUGMAN IS AN ECONOMIST AND YOU ARE NOT. YOU SOUND LIKE THE POLITICIANS IN WASHINGTON WHO ARE ABOUT TO DESTROY AGGREGATE DEMAND BY RAISING TAXES AND CUTTING GOVERNMENT SPENDING. DO THEY REALIZE THAT GOVERNMENT IS THE CREATOR OF MONEY. IF THEY DON’T CREATE IT IT WILL NOT FALL OUT OF THE SKY.