Comments on: Krugman and Wells on the economic slump

Krugman and Wells on the economic slump

russilwvong — Tue, 28 Sep 2010 10:29:18 -0800

Paul Krugman and Robin Wells have a long two-part essay in the New York Review of Books on the current economic slump. The Slump Goes On: Why? And The Way Out of the Slump.

Since around June 2009 many indicators have been pointing up: GDP has been rising in all major economies, world industrial production has been rising, and US corporate profits have recovered to pre-crisis levels. Yet unemployment has hardly fallen in either the United States or Europe--which means that the plight of the unemployed, especially in America with its minimal safety net, has grown steadily worse as benefits run out and savings are exhausted. And little relief is in sight: unemployment is still rising in the hardest-hit European economies, US economic growth is clearly slowing, and many economic forecasters expect America's unemployment rate to remain high or even to rise over the course of the next year.

... So what would we recommend doing? Practically everything that might stimulate [demand]. If more spending on infrastructure is politically impossible, at least make the case for it and pound its opponents for their obstructionism. (It's worth noting that President Obama's recent proposal for a national infrastructure bank is very similar to a proposal that has been endorsed by none other than the bitterly anti-Obama Chamber of Commerce.) Targeted, temporary tax cuts--like the temporary incentives for business investment also recently proposed by the Obama administration--aren't our preferred policy, but they would be better than nothing. And monetary expansion should be pursued through every route possible--yes, it's uncertain how effective any given measure would be, but that's no reason not to try.

Background information: Krugman explains in Vulgar Keynesians (1997) and Baby-Sitting the Economy (1998) how the central bank uses monetary policy to keep the economy stable in normal times, when the problem is inflation, not deflation. When the economy is overheating and inflation is rising, the bank raises interest rates; when the economy goes into recession (because everyone is trying to hold more cash by spending less, resulting in everyone's incomes dropping), and unemployment is rising, the bank lowers interest rates to boost demand. A similar explanation by Janet Yellen (1995 interview):

... the Federal Reserve can, I think, make a contribution on the employment side by mitigating economic fluctuations--by stabilizing real activity. I thus translate the "maximum employment" proviso of the Federal Reserve Act as a mandate for the Fed to lean against the wind, stimulating the economy when the economy is in recession or unemployment is clearly in excess of the NAIRU (the non-accelerating inflation rate of unemployment--the minimum rate of unemployment consistent with stable inflation), and restraining the economy through tighter policy when economic activity is pushing against the limits of capacity with inflationary implications. This is what the Federal Reserve has traditionally done and it is what I think the Fed should continue to do.

But now that the central bank has run into the zero-interest-rate lower bound, making conventional monetary policy ineffective, open conflict has broken out between "saltwater" economists (like Krugman) and "freshwater" economists (like Robert Lucas and Edward Prescott). Krugman explains the history in How Did Economists Get It So Wrong? (2009) (previously). Saltwater economists are pushing for fiscal expansion, temporarily borrowing and spending to boost public demand and compensate for the slump in private demand, rather than cutting public spending to match the slump in tax revenue; they argue that the US had much higher public debt during World War II. Freshwater economists are vehemently opposed to fiscal stimulus, arguing that it's a problem of structural unemployment (a mismatch between skills needed and workers) that the free market will resolve in the long run. Krugman's forecast: political paralysis and continued high unemployment. Some more technical papers: the IS-LM model (1998). Japan's liquidity trap (1998). Japan: still trapped (1999). Optimal fiscal policy in a liquidity trap (2008).

By: yeloson

yeloson — Tue, 28 Sep 2010 10:38:30 -0800

...US corporate profits have recovered to pre-crisis levels. Yet unemployment has hardly fallen in either the United States... You mean to say trickle down economics hasn't magically resolved the issue?

By: Naberius

Naberius — Tue, 28 Sep 2010 10:50:05 -0800

The economy has basically recovered. It's fine. The problem is that since 1980 (November of that year, to be more exact) the economy has been reengineered such that the vast majority of Americans are simply irrelevant to it. It just doesn't matter to the economy whether most Americans have jobs, or can keep their houses, or can otherwise maintain a middle class lifestyle. They've been pinched off, set adrift on an ice floe, whatever metaphor you like. It literally does not matter whether they live or die, and the economy can do just fine while they slowly starve.

By: GuyZero

GuyZero — Tue, 28 Sep 2010 10:53:49 -0800

the economy has been reengineered such that the vast majority of Americans are simply irrelevant to it That's what structural unemployment is. Creating an economy that doesn't need 10%+ of Americans isn't hard (empirically). The problem is that we need an economy that need 99% of Americans employed even if it's worse because unemployment is a lot more than a purely economic problem.

By: otto42

otto42 — Tue, 28 Sep 2010 10:53:49 -0800

Krugman ignores the behavioral aspect of demand side fiscal policy. That is, if enough consumers believe higher government spending will result in higher interest costs in the future, they will adjust their spending lower now to help offset the possibility of higher taxes in the future. In short, an increase in government spending results in a decrease in consumer spending resulting in a wash.

By: existential hobo

existential hobo — Tue, 28 Sep 2010 10:55:25 -0800

Part of the problem is the increased dominance of the financial sector, a sector that still contains inherent risk for the rest of us.

By: GuyZero

GuyZero — Tue, 28 Sep 2010 10:57:43 -0800

In his blog post here Krugman argues against structural unemployment but last year the NY Times ran a piece showing that when nationwide US unemployment was near 10% the unemployment rate for college graduates was more like 4%. It may not be Thatcherite Britain but it's not exactly perfectly matched either.

By: hoople

hoople — Tue, 28 Sep 2010 11:00:26 -0800

ott42: or, perhaps, he's run the numbers in a more concrete fashion than "an increase + a decrease == a wash" -- you know, using actual numbers and things, not just ad-hoc verbal argumentation -- and decided that particular concern has, empirically, proven immaterial enough not to merit specific mention in a popular essay.

By: ennui.bz

ennui.bz — Tue, 28 Sep 2010 11:08:54 -0800

the U.S. economy will continue on in this fashion until the big banks have "earned" their way out of their bad debts or there is a dramatic restaging of "Battleship Potemkin" in San Diego.

By: saulgoodman

saulgoodman — Tue, 28 Sep 2010 11:11:56 -0800

That is, if enough consumers believe higher government spending will result in higher interest costs in the future, they will adjust their spending lower now to help offset the possibility of higher taxes in the future. If you seriously think typical American consumption patterns are in any way, shape, or form informed by economic analysis this sophisticated, you are either tragically inexperienced, ideologically deluded, or willfully obtuse. The farthest most Americans can afford to look ahead in their economic calculus is to the end of the current month, when, if they're lucky, they'll still have some money left to cover any bills that hit late.

By: dgran

dgran — Tue, 28 Sep 2010 11:11:57 -0800

... So what would we recommend doing? Practically everything that might stimulate [demand]. If more spending on infrastructure is politically impossible, at least make the case for it and pound its opponents for their obstructionism. In other words, nobody really knows what will solve the problem, but the problem creates a nice opportunity to play politics and point fingers at anyone who says that government has limited options to fix the problem. Yeah, just what we need.

By: zoogleplex

zoogleplex — Tue, 28 Sep 2010 11:13:02 -0800

This is very interesting, learned a lot that I hadn't picked up before, especially about how Europe was affected, how they did things differently but still got whomped. Thanks russilwvong, good post.

By: ennui.bz

ennui.bz — Tue, 28 Sep 2010 11:14:13 -0800

also, the people who run the U.S. economy see the Yeltsin era of post-collapse Russia as a brief golden age of capitalism (not surprisingly since people like Rubin and Summers helped engineer the looting of the Soviet Union) and are eager to see a repeat in the U.S.

By: Pastabagel

Pastabagel — Tue, 28 Sep 2010 11:18:16 -0800

US corporate profits have recovered to pre-crisis levels... This is misleading. Profits have only recovered to pre-crisis levels for those companies still around. The number of companies that went out of business in 08 and 09 is enormous. And the solution is not to spend money on infrastructure, because the infrastructure we have was originally put in place for a country whose economy was centered around manufacturing. The economy is now centered around consumption and finance in an environment of rising commodity prices. Anyone else notice that gas is back to around $3.00 a gallon?

By: zoogleplex

zoogleplex — Tue, 28 Sep 2010 11:25:21 -0800

To be fair, Pastabagel, we do need to spend some money on infrastructure - especially on refurbishing the many bits of it that are getting dangerously decrepit. Since you mention gas prices (and by extension energy prices in general), what about investing in long-term city- and regional-level transportation infrastructure that (in theory) would increase our energy efficiency (i.e. mass transit, trains, etc.)?

By: ennui.bz

ennui.bz — Tue, 28 Sep 2010 11:26:18 -0800

That is, if enough consumers believe higher government spending will result in higher interest costs in the future, they will adjust their spending lower now to help offset the possibility of higher taxes in the future. This is why consumers never run up huge credit card debts, because they know that the ~~tax~~ interest due in the future will cripple their ability to spend...

By: peppito

peppito — Tue, 28 Sep 2010 11:27:45 -0800

I agree with Krugman, more stimulus still needed - was really needed a year or two ago.

By: otto42

otto42 — Tue, 28 Sep 2010 11:29:29 -0800

saulgoodman: The typical American consumer does not have to perform an analysis of estimated future tax liabilities and its effect on his current spending habits. All he has to know is that taking out a big loan now will reduce his future net cash flows. Most consumers know this when they take out a big mortgage and they know the same principal applies when the government takes out a big loan (for stimulus.)

By: angrycat

angrycat — Tue, 28 Sep 2010 11:30:13 -0800

Fascinating youtube representation of unemployment levels in U.S.

By: GuyZero

GuyZero — Tue, 28 Sep 2010 11:30:43 -0800

Per Friedman's recent turnabout op-ed piece on the booming infrastructure buildout in China, the US' biggest problem in rebuilding its infrastructure is that it's also trying to rebuild Iraq and Afganistan at the same time. Most MeFites have a way to free up a few billion out of the budget for domestic stimulus pretty quickly.

By: notion

notion — Tue, 28 Sep 2010 11:37:00 -0800

This is a simple issue of accountability. People are paid handsomely for things that are not work. Interest income is not work. Owning stock is not work. Having money is not work. Pretty much the entire financial services sector does nothing useful for the rest of society. It's just a casino. The stock market used to exist to provide money for capital investments, like machinery, factories, or other reality-based employment providers. Now the money just floods into variations of ponzi schemes. Who wants to wait 20 years to see a return on investing in a solar panel factory when you can just invent a perpetual interest machine and have the public bail you out when it inevitably fails? Adam Smith himself said, "With the great part of rich people, the chief employment of riches consists in the parade of riches." Unless America wants to turn the vast majority of it's citizens into foot servants for the ultra wealthy, we need to return to sane progressive tax policies. We need to stop lending money at zero percent interest to banks, unless they turn around and lend that money to small businesses and individuals. If you don't take a small slice of the money that's only bound to raise the going price of faberge eggs and antique vases, and do something useful with it like creating jobs to build a road or a school, our economy will continue to stagnate.

By: Xoebe

Xoebe — Tue, 28 Sep 2010 12:00:50 -0800

"Krugman ignores the behavioral aspect of demand side fiscal policy. That is, if enough consumers believe higher government spending will result in higher interest costs in the future, they will adjust their spending lower now to help offset the possibility of higher taxes in the future. In short, an increase in government spending results in a decrease in consumer spending resulting in a wash." The only people for whom that is even remotely a consideration are people in the highest income brackets. Many, if not most, Americans cannot adjust their spending enough to compensate for anything that may happen in their future. Certainly human beings, being human beings, aren't going to adjust their spending now based on what may happen in the future anyway. The people we should be concerned about are working class. These comprise the bulk of the unemployed. Of course, there are large numbers of professional class - teachers, engineers, architects, high tech professionals, etc., who are also unemployed, but by and large the idea that these people actually are part of a "middle class" is a myth. There are many carpenters, framers, electricians, etc. - the classic working class - who are as well off financially as many professionals. Working in an air conditioned building is not an adequate distinction. One could have seen this coming decades ago. I am no economist, and I did. In the second half of the 20th century, as industrial and tangible goods producing jobs were supplanted by service sector jobs, it was obvious that we weren't going to be producing anything by selling each other services. The service sector ride has been prolonged by globalization. Being able to buy cheap foreign goods at Wal Mart masked the fact that we were exporting our ability to buy those goods - despite the fact that economists lamented huge trade deficits for decades. Also, the expansion of consumer credit helped to finance this. A lot of people have made a lot of money by procuring or producing goods overseas and bringing them to first world countries. Those financial gains were not translated into increased wages and benefits for American workers, since the productive worker base was shrinking, and there was no incentive to satisfy American labor, since foreign labor was still so much cheaper - and will be, for the time being. The only way the average American would have seen a benefit would have been to tax the windfalls and incomes of those at the highest levels - obviously that isn't very popular with those whose windfalls and incomes we are talking about, and they are the ones with the greatest political clout. It's time to pay the piper, and we had better get serious about it. We haven't even begun to deal with the havoc that will be wreaked upon the global economy when China changes their economic policies and lets the value of the yuan rise freely. Those cheap goods will disappear overnight, and it will take decades for Americans to redevelop our industrial base. It may not matter anyway - I suspect that a great deal of American industrial success in the 20th century was due to the fact that Europe was engulfed in war for a couple of decades, and after the Second World War, their industrial base was decimated - leaving an untouched America to produce goods for twenty to thirty years. The one American industry that is ultimately it's trump card is agriculture. We may not be able to compete with cheap industrial labor, but now and for the foreseeable future, America is the world's breadbasket. It's unclear how this will play out, but you can bet it will be an ugly 21st century as the developing world tries to obtain food from us at first world prices. Supply side economics has at it's core a kernel of truth. Investors need to make money, or there won't be industries to employ anyone at all. That's really only true when industries are in their infancies. Once the infrastructure is in place, it's industry's job to ensure they are competitive - and they need markets to sell to. Demand side economics means that there are markets to sell to. There is much empirical evidence, especially in the U.S. that pretty well discredits supply side economics, and vindicates demand siders. The arguments that structural issues are to blame for high unemployment are the same ones that were made by the Right during the Depression of the 1930s. It took massive investments in the name of war to help bring the U.S. out of that quagmire. Let's hope that's not the reason we do it again. To make a long story short, I quote yeloson, from above: "You mean to say trickle down economics hasn't magically resolved the issue?"

By: Xoebe

Xoebe — Tue, 28 Sep 2010 12:05:45 -0800

I want to add, that notion pretty well said the same thing as I did, just before I posted, but his is a lot easier to read.

By: wuwei

wuwei — Tue, 28 Sep 2010 12:05:58 -0800

The problem is that the monetary policy doesn't actually work because the money multiplier we all learned about in Econ 1A is empirically non-operative: "The Fed study concluded that "if the level of reserves is expected to have an impact on the economy, it seems unlikely that a standard multiplier story will explain the effect."" Also, the concept of NAIRU, while plausible sounding, lacks an empirical basis as well.

By: saulgoodman

saulgoodman — Tue, 28 Sep 2010 12:19:19 -0800

Also, the expansion of consumer credit helped to finance this. As I heard someone else point out on the radio the other day, we've used the extension of easy credit (the use of which, perversely, is often used as a moralistic cudgel to beat the middle and working class over the head) to gloss over the reality of wage stagnation. The upper tier of the economy wanted to see continued economic growth so that their own capital reserves continued to swell, but they didn't want to do this by actually giving up any claim to their capital, so instead of raising wages, they devised mechanisms to make it easier to lend money to workers, effectively allowing them to both keep their money (and make money on it) while at the same time, allowing it to be spent to keep the economy growing (which also kept more money coming their way). As a perverse reward for their increased productivity, American workers were/are systematically fleeced on both sides of the deal.

By: Cranberry

Cranberry — Tue, 28 Sep 2010 12:22:23 -0800

How come President Obama is blamed for unemployment instead of the National Association of Manufacturers who are the ones not hiring in the US?

By: SouthCNorthNY

SouthCNorthNY — Tue, 28 Sep 2010 12:24:26 -0800

Professor Raghuram G. Rajan, one of the authors Krugman criticizes, responds in a lengthy piece: http://freakonomics.blogs.nytimes.com/2010/09/16/correcting-krugman/

By: notion

notion — Tue, 28 Sep 2010 12:25:48 -0800

How come President Obama is blamed for unemployment instead of the National Association of Manufacturers who are the ones not hiring in the US? Because news corporations have no incentive to tell the truth.

By: thsmchnekllsfascists

thsmchnekllsfascists — Tue, 28 Sep 2010 12:57:05 -0800

I agree with Krugman, more stimulus still needed - was really needed ~~a year or two ago.~~ 15 years ago. FTFY

By: euphorb

euphorb — Tue, 28 Sep 2010 13:02:37 -0800

The issue of structural versus cyclical unemployment is one of the dumbest debates I've seen played out over the past few years. The idea that there are large number of professional economists and financial types who believe that unemployment is at 10% because there is some sort of mismatch between jobs and job skills needs to get outside into the real world. The slowdown cut across all industries and sectors. There is an unending stream of data that shows this. If there were a structural problem then there would have been lots of industries that increased hiring during the recession and had trouble finding qualified labor. But that just wasn't the case then and isn't now I'm trying to imagine what the equivalent debate would be in other fields. It would be like if a large portion climate scientists insisted that global warming is caused by Argon gas instead of CO2 or physicians who believe that swine flu is caused by an allergic reaction to bologna. These people would be laughed out of their fields. It really says something about the implosion of the field of economics over the past few years. that the experts have no clue what they are talking about. For a look at some of the evidence, Krugman covers that structural vs cyclical issue here, here and here.

By: Brocktoon

Brocktoon — Tue, 28 Sep 2010 13:39:33 -0800

How come President Obama is blamed for unemployment instead of the National Association of Manufacturers who are the ones not hiring in the US? Because he's black/Hitler/Stalin, duh.

By: Long Way To Go

Long Way To Go — Tue, 28 Sep 2010 13:55:05 -0800

How come President Obama is blamed for unemployment instead of the National Association of Manufacturers who are the ones not hiring in the US? Because news corporations have no incentive to tell the truth. Not even wrong.

By: peppito

peppito — Tue, 28 Sep 2010 14:37:10 -0800

By: Civil_Disobedient

Civil_Disobedient — Tue, 28 Sep 2010 17:00:35 -0800

the National Association of Manufacturers who are the ones not hiring in the US I heard a show on public radio about five months ago where they were interviewing some business owner who was complaining about how he couldn't get any credit. He had all these orders coming in—there was real work to be done, real money to be paid—but he couldn't afford to take on these contracts unless he could secure a loan from his bank (to hire more workers, to buy more materials, etc.) This was the bank he'd been using for decades. Without capital you're just fucked.

By: weston

weston — Tue, 28 Sep 2010 17:32:30 -0800

All he has to know is that taking out a big loan now will reduce his future net cash flows. Most consumers know this when they take out a big mortgage and they know the same principal applies when the government takes out a big loan (for stimulus.) Which is why new and/or growing businesses never take out loans or sell equity in return for an infusion of cash "stimulus."

By: kliuless

kliuless — Tue, 28 Sep 2010 18:00:32 -0800

rajan's response is worth reading (krugman's response and other differences in degree wrt housing subsidies writ large) i think because he lays the blame -- the root cause -- of the financial crisis and economic recession w/ rising inequality, which i find interesting :P the FT i thought bottom-lined it nicely!

Take Applied Materials, a big US manufacturing company, which earlier this year shifted its chief technology officer and research and development operations to China. The company said it needed its R&D to be close to the source of its manufacturing operations and to its biggest future market. This is the opposite of what is supposed to happen. America was meant to keep the high-end jobs at home, while China would get all the low-value added production. But in practice researchers benefit from proximity to the production processes, which require constant trial and error. A cursory look at the US's trade deficit illustrates the trend. Far from importing low cost manufactured goods, the US is buying high-tech stuff from such countries as China and Brazil, including aircraft engines, computers, turbines and heavy duty trucks. And it is exporting growing volumes of low-tech stuff, including pulp and paper, oil seeds and other commodities. People who lose their jobs in the US are on average moving to jobs that pay roughly a fifth less than their previous jobs. Others are having difficulty finding any jobs at all. That trend has only been accelerated by the Great Recession. According to Manufacturing and Technology News, the number of US workers displaced by US trade policy rose by 59 per cent in 2009 over 2008, thus qualifying for special benefits from the US Department of Labor. The same publication reports that the US now accounts for less than 5 per cent of global solar panel production despite the fact that it invented the technology in the 1980s. The direction is hard to deny. America is not producing new jobs in anything like the quality or the quantity it needs to replace the high-end jobs it is losing.

for more background here's an excerpt (self-link!) from the end of influence that i thought was a particularly nice overview :P cohen & delong, in turn, believe much of the blame/cause lies in finance (as does cowen). anyway, i agree w/ the prescription -- krugman,* bartlett, cowen cf. tinkerbell, BOE wants more (fed working on it) -- but i feel like w/out addressing the causes it'll be like zakaria sez where "the problems we face in the future are less like heart attacks and more like cancer—problems that if unattended will grow and metastasize." to me if you look at, say The Perennial Quest to Lower Health Care Spending [1,2,3,4] the task seems insurmountable, or like the mountain of debt we still have to work thru (which raising the price level is designed to help), given institutional sclerosis, winner-take-all politics and private sector 'efficiency' ... the whole shirky/tainter [1,2] thing :P but, like cowen sez, "then one day some new technological development will change everything,"** altho he's quick to add, "It's an open question whether this will happen before or after the sovereign debt crisis." cheers!*** --- *War on depression; also somewhat stirring to me was reading John Maynard Keynes's Private Letter to Franklin Delano Roosevelt of February 1, 1938. for example:

(5) Businessmen have a different set of delusions from politicians, and need, therefore, different handling. They are, however, much milder than politicians, at the same time allured and terrified by the glare of publicity, easily persuaded to be 'patriots', perplexed, bemused, indeed terrified, yet only too anxious to take a cheerful view, vain perhaps but very unsure of themselves, pathetically responsive to a kind word. You could do anything you liked with them, if you would treat them (even the big ones), not as wolves or tigers, but as domestic animals by nature, even though they have been badly brought up and not trained as you would wish. It is a mistake to think that they are more immoral than politicians. If you work them into the surly, obstinate, terrified mood, of which domestic animals, wrongly handled, are so capable, the nation's burdens will not get carried to market; and in the end public opinion will veer their way. Perhaps you will rejoin that I have got quite a wrong idea of what all the back-chat amounts to. Nevertheless I record accurately how it strikes observers here. (6) Forgive the candour of these remarks. They come from an enthusiastic well-wisher of you and your policies. I accept the view that durable investment must come increasingly under state direction. I sympathise with Mr Wallace's agricultural policies. I believe that the SEC is doing splendid work. I regard the growth of collective bargaining as essential. I approve minimum wage and hours regulation. I was altogether on your side the other day, when you deprecated a policy of general wage reductions as useless in present circumstances. But I am terrified lest progressive causes in all the democratic countries should suffer injury, because you have taken too lightly the risk to their prestige which would result from a failure measured in terms of immediate prosperity. There need be no failure. But the maintenance of prosperity in the modern world is extremely difficult; and it is so easy to lose precious time...

**see i would include institutional change as well, per romer ***that is all!

By: tgrundke

tgrundke — Wed, 29 Sep 2010 05:17:59 -0800

If you're getting your economic analysis from Krugman, you're just as well off tuning into MSNBC and watching the bobbleheads there like Kudlow, Liesman and Bartoromo. Krugman is the Jay Leno of economics - lots of pop references but never really on the edge of the curve and always playing out that old joke for as long as it will get a laugh. I've said it before and will repeat it until I'm blue in the face: this economic mess has been brought about by the excessive use of credit, spent on non-productive assets that are now deflating in value as people realize they were terribly oversold investment vehicles (eg: real estate). The American consumer has been on a debt binge for 20 years and we've hit the point of diminishing returns, where it now takes more debt to generate a dollar of true wealth, than it is worth. Until the debts are paid down and the malinvestment purged from the system we are going to plod along this course we find ourselves on today. Credit is available in droves - nobody wants it. Interest rates are at historical lows, nobody's buying. Additional stimulus does nothing but push a wet noodle when the real problem is not demand - it's DEBT. When you live in an economy dependent upon constant growth, you get to a point where credit generation is absolutely necessary to keep the system running. We've done that and we're like the python who has gorged itself on a large animal - we need to absorb and digest before heading back to the credit trough. Our economy has essentially been one giant bubble after the other since the early 1990s. One bubble blows up, the Fed has no choice but to blow another bubble to keep things moving along. Once S&L blew up, capital found its way to technology, once that blew up it found its way to real estate, the last real asset class which hadn't seen a major bubble. Now that we've blown up real estate the question is twofold: one, what's the next asset class to be blown up, and two, are there enough suckers left standing to be willing to fall for it this time? This is a generational shift - much as our grandparents were thrifty as a result of the 1930s depression, we're seeing a slow but methodical shift back to thriftiness today. There's less trust of financial institutions (look at trading volume on Wall Street this year), less up-sizing and more down-sizing. Granted, it can be argued that these are forced austerities and not by choice, but they will probably lead to an overall generational shift away from credit.

By: Protocols of the Elders of Sockpuppetry

Protocols of the Elders of Sockpuppetry — Wed, 29 Sep 2010 09:45:11 -0800

Demand should be stimulated indefinitely until every resource of the planet is permanently exhausted.

By: saulgoodman

saulgoodman — Fri, 01 Oct 2010 07:47:10 -0800

Guess it's just too much to hope for actual wage growth as an alternative to credit--oh, wait, sorry, I didn't use the officially-approved, negative connotation laden "wage inflation" term of art. Of course, in the real world, wages growing over time is categorically a bad thing--even while profits growing over time is categorically a good. Obviously.

By: russilwvong

russilwvong — Fri, 08 Oct 2010 10:40:54 -0800

tgrundke: The American consumer has been on a debt binge for 20 years and we've hit the point of diminishing returns, where it now takes more debt to generate a dollar of true wealth, than it is worth. Until the debts are paid down and the malinvestment purged from the system we are going to plod along this course we find ourselves on today. I agree that households need to consume less, save more, and pay down their debts. But that's not going to get the US out of its economic slump. The babysitting story illustrates this: if everyone simultaneously tries to save more by spending less, all that happens is that everyone's income is reduced, and you have high unemployment. In short, the US is currently in the same situation that Japan's been in since the 1990s. It's not going to recover on its own: this is a stable situation. (You said elsewhere that you think there'll be deflation in the short term, but inflation in the long term, because of the increase in the money supply. Don't forget the role of the central bank: if the US gets out of the slump, then once unemployment comes down and inflation becomes a threat, the central bank can easily prevent inflation by converting money to bonds, thus raising the interest rate. We can revisit this in a few years and see how your prediction turned out.) If you break down GDP into its components:

GDP = consumption + investment + government spending + exports - imports

GDP = C + I + G + X - M

If households reduce their consumption C, but GDP drops at the same time (because business confidence is low and thus investment I is low), all that happens is that GDP runs under capacity and unemployment is high. Which is exactly what's happened. In order for households to actually increase their savings, GDP needs to be running at closer to its full capacity (i.e. unemployment needs to go down). Given the current state of the world economy, raising exports X and lowering imports M isn't going to do it. So government spending G needs to be higher. Krugman's most recent column talks about this:

And right now, by any rational calculation, would be an especially good time to improve the nation's infrastructure. We have the need: our roads, our rail lines, our water and sewer systems are antiquated and increasingly inadequate. We have the resources: a million-and-a-half construction workers are sitting idle, and putting them to work would help the economy as a whole recover from its slump. And the price is right: with interest rates on federal debt at near-record lows, there has never been a better time to borrow for long-term investment.

Infrastructure spending is also a good candidate because it's temporary by nature. A more right-wing solution would be arms spending, I suppose. In Canada, commentators often note that government budgets needs to be balanced over the course of the business cycle. When the economy is doing well, the government should run surpluses; when it's in a slump, the government should run deficits. The fact that state and local governments in the US can't run deficits (meaning that when there's a recession and tax revenue drops, government cutbacks aggravate the problem) really surprises me.

By: tgrundke

tgrundke — Mon, 11 Oct 2010 18:32:18 -0800

russilwvong - Great points, all of them, and duly noted. That said, I think we're in a slightly different paradigm (*shudder* at that phrase) where government spending to make up for the lack of consumer spending really isn't working this time around. I fully understand the dilemma of everyone cutting back simultaneously, but we're at a tipping point where the debt burden is quite literally burying us. In fact, I don't have the numbers or the link to it, but I know I read several economic journals recently stating that we've reached the point where to create $1 dollar of wealth the government essentially is spending $2 to do so. Once I find it, I'll post up those links because it was an interesting read. You've got families in America that are literally living paycheck to paycheck - their entire income is consumed and in many cases this is to service debt. Easing credit isn't going to get them to take on more credit necessarily if their income is not rising. Same goes for businesses - credit has been so cheap and easy the past 10 years (and still is) that lower rates are spurring investment income because, as most small business owners will tell you, there is no reason to take on additional credit because there is no demand - we're all treading water these days, at best. The problem with Keynesian economics is that economists and politicians conveniently forget the crux of Keynes proposal: save during the good years so you can spend during the lean years to help moderate the cycles. We've failed to do that since World War II, and lacking a strong export sector we have few products to sell outside of the United States as compared to Asia and Latin America. Now let's combine that with the current policy of dollar debasement. This is due to a combination of factors, but the end game is higher commodity and import prices, which will suck the life out of any recovery that takes place. Here's where the Fed is walking an extremely tight rope - once investors determine that they can get good returns on commodities and/or the dollar continues its slide, input prices will escalate and affordability will continue to drop. None of this is inevitable, of course, but the root of it all is debt.

By: russilwvong

russilwvong — Tue, 12 Oct 2010 17:22:41 -0800

In fact, I don't have the numbers or the link to it, but I know I read several economic journals recently stating that we've reached the point where to create $1 dollar of wealth the government essentially is spending $2 to do so. Once I find it, I'll post up those links because it was an interesting read. Sure, I'd be interested in seeing these articles. It's not just consumer spending. Right now non-financial businesses in the US are holding onto $2 trillion in cash. Easing credit isn't going to get them to take on more credit necessarily if their income is not rising. Er. Krugman and Wells aren't advocating stimulating the economy by lowering the cost of credit (which is already at zero). They're advocating having the government borrow money (at low long-term rates) and spend it on infrastructure projects, which would indeed raise the incomes of the workers who would otherwise be unemployed. Krugman's argument is that the stimulus was too small. January 2009. Also see Adam Posen on Japan: Fiscal Policy Works When It Is Tried (1998). ... lacking a strong export sector we have few products to sell outside of the United States as compared to Asia and Latin America. ... Now let's combine that with the current policy of dollar debasement. But the two are related, right? In order for US exports to be more competitive, the US dollar needs to fall against the currencies of its trading partners. Again, I don't see inflation as a problem, while you do; we'll have to wait a few years to see who's right.