By MATTHEW BISHOP
Published: June 15, 2012
Nearly four years on from the financial meltdown that plunged it into
recession, the global economy remains fragile. The latest green shoots
of recovery in the United States already show signs of turning brown. It
is touch and go whether Barack Obama will enter the polls with
unemployment above or below the 8 percent rate that usually means defeat
for an incumbent president. Across the Atlantic, the euro zone stumbles
from crisis to crisis; the continuing problems of the heavily indebted
PIIGS (Portugal, Ireland, Italy, Greece and Spain) remain the basis for
many a nightmare, some of the worst involving the banks around the world
that own much of the debt.
Illustration by Paola Rollo
If ever there was a moment for fresh thinking, this is surely it.
Indeed, Paul Krugman argues in “End This Depression Now!,” without a
radical change in economic policy in both the United States and Europe,
the likeliest outcome is a prolonged depression, perhaps not as “great”
as in the 1930s but with clear similarities, above all in the immense
human cost of needlessly high unemployment. As Krugman sees it, fiscal
austerity, a fashionable idea on both sides of the Atlantic, can only
make matters worse. This new “austerian” conventional wisdom, Krugman
says, has “completely thrown away Keynes’s central dictum: ‘The boom,
not the slump, is the time for austerity.’ ”
Not surprisingly, as today’s leading interpreter of John Maynard Keynes,
Krugman uses Keynes’s definition of a depression, “a chronic condition
of subnormal activity for a considerable period without any marked
tendency either towards recovery or towards collapse.” He attributes
this to a classic Keynesian “liquidity trap,” in which an indebted
private sector is so intent on rebuilding its savings that even interest
rates of zero cannot tempt it to borrow and spend enough to get the
economy working again at full capacity. And he offers the classic
Keynesian remedy of the government making up for the lack of private
spending by splashing the cash around itself. Even now, Krugman argues,
full employment could be restored to the United States in less than two
years, given the political will to spend a lot of money.
How much money? Ideally, enough to generate inflation of 4 percent a
year, Krugman says, breaking another of today’s economic taboos by
arguing that a bit of inflation would be good for us. He is particularly
dismissive of the fact that the “Germans hate, hate, hate” inflation,
owing to memories of the great inflation of the 1920s; in fact it was
the deflationary policies of the 1930s, he tells us, that “actually set
the stage for the rise of you-know-who.” One of the advantages of
inflation cited by Krugman is that it reduces the real value of all that
depression-inducing debt, like the mortgages people use to buy homes.
On today’s current low inflation trend, Krugman anticipates prices being
8 percent higher in 2017 than today. But, he says, “if we could manage 4
or 5 percent inflation over that stretch, so that prices were 25
percent higher, the real value of mortgage debt would be substantially
lower than it looks on current prospect — and the economy would
therefore be substantially farther along the road to sustained
recovery.”
Longtime readers of Krugman will know there are at least two of him. One
is the gifted winner of the Nobel in economic science, respected
throughout the academy for his mastery of the dismal science; the other,
the populist polemicist and baiter of the right who writes columns in
The New York Times. “End This Depression Now!” is a collaborative effort
by the two Krugmen. Professor Krugman usefully contributes plenty of
mainstream economics in support of his stimulus plan and in order to
debunk the idea that austerity policies in today’s circumstances can
boost an economy by increasing confidence. (As he points out, Britain,
the leading country to embrace austerity voluntarily, is hardly setting
the world on fire.) Yet no opportunity to preach to the choir is missed
by the populist Mr. Krugman, nor any chance to mock those he calls the
“Very Serious People” who disagree with him. This is often entertaining:
during a stern speech in 2010 by Germany’s finance minister, Krugman’s
wife dismissed those who regard austerity as a sort of moral
purification with the whispered aside, “As we leave the room, we’ll be
given whips to scourge ourselves.” But the book’s preachiness gives
those politicians and economists who most need to read this book an easy
excuse to ignore it.
To this Moderately Serious Reviewer, Krugman’s habit of bashing anyone
who does not share his conclusions is not merely stylistically
irritating; it is flawed in substance. The rise in unemployment may be
largely the result of inadequate demand, but that does not mean there
has been no contribution from structural changes like the substitution
of cheap foreign workers and innovative technology for some jobs in rich
countries. The austerians may be excessively fearful of so-called “bond
vigilantes,” but that does not mean there is no need to worry about
what investors think about the health of a government’s finances. Sure,
ridicule those fundamentalists who believe it is theoretically
impossible for an economy ever to suffer a shortage of demand, but does
Krugman really need to take passing shots at Erskine Bowles and Alan
Simpson, the chairmen of the widely respected bipartisan Bowles-Simpson
Commission on deficit reduction appointed by President Obama? Maybe his
case for stimulating the economy in the short run would be taken more
seriously by those in power if it were offered along with a
Bowles-Simpson-style plan for improving America’s finances in the
medium or long term. Instead, Krugman suggests cavalierly that any extra
government borrowing probably “won’t have to be paid off quickly, or
indeed at all.”
Krugman seems to have given up on directly influencing policy makers and
mainstream economists, opting instead to appeal over their heads to “an
informed public.” Perhaps this makes sense. If his arguments win in the
end, it may well be because, ultimately, the public does not have the
stomach for prolonged austerity (perhaps after experimenting with it
first by, say, electing a President Romney), and politicians will
conclude that borrowing and inflating the debt away is a lot more
palatable than cutting public spending and/or raising taxes.
Whether that would be as marvelous as Krugman says is debatable.
Inflation imposes real costs, for instance on retired baby boomers
reliant on fixed dollar annuities and on foreign investors in government
bonds. How those bondholders would respond is anyone’s guess, though
they might shift away from the dollar or euro to other currencies or to
alternatives like gold. Inflation would certainly increase the risk of
the dollar losing its status as the world’s reserve currency, with
potentially serious political consequences like competitive
devaluations, accusations of currency manipulation, trade wars and maybe
worse (as Krugman, an expert in the economics of trade, well knows). In
wanting to give top priority to helping the unemployed, Krugman’s heart
is clearly in the right place. Yet it would have made for a better book
if he had offered a fuller discussion of the potential consequences of
his policies, rather than evading it by citing Keynes’s famous
observation that “in the long run we are all dead.”
Matthew Bishop, the New York bureau chief of The Economist, has
written several books on economics and is the author, with Michael
Green, of the e-book “In Gold We Trust? The Future of Money in an Age of
Uncertainty.”
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