[As a courtesy to our guests, please keep comments to the book and be respectful of dissenting opinions. Please take other conversations to a previous thread. - bev]
It is an honor and a pleasure to have Paul Krugman at the Lake this afternoon for a conversation on End This Depression Now! Dedicated “To the unemployed, who deserve better,” the book is a condemnation of the policies and mind-set that have produced the worst economic depression since the 1930s. And unlike the Great Depression, which contemporaries did not understand, we know what to do; the current depression is entirely self-inflicted. The broken homes and ruined lives are not attributable to acts of God or the inscrutable logic of the market, but are the direct consequence of public decisions that have amplified the inherent risk of private credit by deregulating financial operations and the attempt to balance the budget when aggregate private demand is collapsing. The central message is that none of this suffering is necessary, and none of it is justified.
I believe I do Paul no disservice in pointing out that none of this is new. If a non-tenured assistant professor were to publish this book, she might be denied tenure for wasting time on simple things instead of contributing to the advance of Economic Science. It used to take a little boy to declare that “the emperor has no clothes”; it apparently now takes a Nobel Laureate.
The basic economics of counter-cyclical fiscal policy is not rocket science, though the reasons why firms can adjust production and employment faster than the economy can adjust prices and wages are complicated and subtle. But we don’t have to master the subtleties to understand that when private demand collapses, the short-term offset is a rise in the government deficit. If firms and households want to spend less than they earn, some other sector–i.e., the government or foreigners–has to spend more than it earns. Because one person’s spending is another person’s income, it is arithmetically impossible for all sectors of an economy simultaneously to spend more than they earn.
The government cannot run a surplus when the private sector is also running a surplus. If it attempts to do so, the resulting deficiency in aggregate demand will cause firms to reduce output (and therefore income) until the government tax revenues (and private saving) fall to the point where the deficits and surpluses match. This is what is currently happening in Greece, Spain, and Britain. Austerity makes things worse, not better. In principle, falling interest rates resulting from excess saving ought to stimulate private investment, but that option is ruled out when interest rates are already at rock bottom and much of the capital stock currently in place is idle. In such circumstances the only alternative is for the government to run a higher deficit. This simple accounting truth has been known for seventy years.
This brings us to the book’s second theme. If the technical remedy to a demand-based depression is so simple and has been around for so long, why has it been studiously avoided, derided, and actively opposed? What developments in political life and academic economics make unacceptable everyone forty years ago agreed should be done when demand collapses? The political consequences of the massive increase in income and wealth inequality are a prime cause of the policy impasse at the Federal level. Indeed, it is evident that certain elements of American society probably prefer high to low unemployment because it weakens labor’s power to bargain for better wages and working conditions. Though the point is common currency here at the Lake (hand-wave to masaccio), it is a powerful and somewhat dangerous admission for a mainstream economist.
But income inequality and perverse financing of electoral campaigns is not the whole story, and certainly does not explain the self-destructive policy of austerity in the eurozone, or the derision to which economists who advocate expansionary fiscal policy are subjected by certain well-known mainstream economists. Robert Barro (who believes government spending crowded out private spending during World War II, apparently forgetting that private goods were rationed) has suggested that Paul is not qualified to comment on macroeconomics. James Cochrane of the University of Chicago characterizes Keynesian economics as ‘fairy tales that have been proved false.” By whom and how, one asks? Is our current state simply a bad dream? Hypertrophic mathematical elaboration of macroeconomic models premised on market-clearing as one of the ‘first principles’ of economic reasoning is a major culprit. The models assert that such unemployment as exists is due to government and social interference with those principles. As Dean Baker quips, the first principles of economics also teach us that there is a price at which some economists are willing to say anything.
This is a passionate book. Beyond the wonkery (very limited) it meets the obligation to tell the truth. Part of that truth is the simple macroeconomics of aggregate demand; in the short run it is the truth that counts most, because lack of demand is wrecking the lives of millions of people. The deeper truths about politics and the nihilism of contemporary mainstream macroeconomics are more disturbing. They go to the heart of what we are becoming as a people and (to be parochial) as economists. Paul has peered into the abyss; it isn’t pretty. There are a lot of things that are wrong with our economic organization. This book argues for doing first things first. The first thing is to get people back to work in productive jobs. This can be done immediately. The impossible takes longer.
On the principle that pictures are worth thousands of words, I have copied several graphs from the book plus one from elementary macroeconomics to provide reference points for discussion.
The point at which the AE line crosses the 45 degree line determines the level of output and employment supported by current spending. A rise in that function causes a rise in that level, lowering it causes output to fall. I put this diagram up without labeling the axes as a Rorschach test for young faculty and graduate students in our macro reading group. It took a while before one of the professors tentatively said ‘Keynesian Cross?’
Why the stimulus package failed to restore full employment. It consisted almost entirely in automatic stabilizers.
Despite repeated cries of alarm that the US National Debt is out of control, the cost of government borrowing declined. The spikes are ‘Confidence Fairy’ sightings.
Where the money went: Also known as the liquidity trap.
The history of the euro in one graph.
This should be enough to get us started. Paul, welcome back to the Lake. It’s sometimes a bit choppy, but it’s clear sailing.