Krugman’s “However”

One of my college profs used to say that he ignored every undergraduate paper until the first “however”. Here’s the “however” in Paul Krugman’s most recent New York Times column:

The problem, instead, is that the Europeans, and the Germans in particular, treat themselves badly, with a ruinous obsession over public debt. And the costs of that obsession are spilling over to the world as a whole.

Some background: Around 2010, politicians and pundits on both sides of the Atlantic caught a bad case of austerity fever. Somehow they lost interest in fighting unemployment, even though it remained catastrophically high, and demanded spending cuts instead. And these spending cuts, unprecedented in a weak economy, slowed the recovery and delayed the return to full employment.

While debt alarmism ruled both here and in Europe, however, it eventually became clear that there was a crucial difference in underlying motivation. Our deficit hawks were, in fact, hypocrites, who suddenly lost all interest in debt as soon as a Republican was in the White House. The Germans, on the other hand, really meant it.

True, Germany forced debt-troubled nations in southern Europe into punishing, society-destroying spending cuts; but it also imposed a lot of austerity on itself. Textbook economics says that governments should run deficits in times of high unemployment, but Germany basically eliminated its deficit in 2012, when euro area unemployment was more than 11 percent, and then began to run ever-growing surpluses.

Why is this a problem? Europe suffers from a chronic shortfall in private demand: Consumers and corporations don’t seem to want to spend enough to maintain full employment. The causes of this shortfall are the subject of a lot of debate, although the most likely culprit is demography: low fertility has left Europe with a declining number of adults in their prime working years, which translates into low demand for new housing, office buildings, and so on.

He is being far too kind. If Germany were still using the mark, the massive trade imbalances that Germany maintains with its European trading partners would resolve themselves. Either the Germans would continue to accept decreasingly valuable lira, drachma, and pesos, it would need to import more from Italy, Greece, and Spain, or Germans would need to purchase more and more (highly inflated) Italian, Greek, and Spanish assets. As it is they just accept the euros and go merrily on their way. The increasing debts of their trading partners are largely held by German banks so they have the debt service working to their advantage as well as long as nobody defaults.

That’s what the German attitude towards debt is based on: preserving German banks.