Paul Krug­man and the Obama re­cov­ery

Financial Mirror (Cyprus) - - FRONT PAGE -

For sev­eral years, and of­ten sev­eral times a month, the Nobel lau­re­ate economist and New York Times colum­nist and blog­ger Paul Krug­man has de­liv­ered one main mes­sage to his loyal read­ers: deficit-cut­ting “aus­te­ri­ans” (as he calls ad­vo­cates of fis­cal aus­ter­ity) are de­luded. Fis­cal re­trench­ment amid weak pri­vate de­mand would lead to chron­i­cally high un­em­ploy­ment. In­deed, deficit cuts would court a reprise of 1937, when Franklin D. Roo­sevelt pre­ma­turely re­duced the New Deal stim­u­lus and thereby threw the United States back into re­ces­sion.

Well, Congress and the White House did in­deed play the aus­te­rian card from mid2011 on­ward. The fed­eral bud­get deficit has de­clined from 8.4% of GDP in 2011 to a pre­dicted 2.9% of GDP for all of 2014. And, ac­cord­ing to the In­ter­na­tional Mon­e­tary Fund, the struc­tural deficit (some­times called the “full-em­ploy­ment deficit”), a mea­sure of fis­cal stim­u­lus, has fallen from 7.8% of po­ten­tial GDP to 4% of po­ten­tial GDP from 2011 to 2014.

Krug­man has vig­or­ously protested that deficit re­duc­tion has pro­longed and even in­ten­si­fied what he re­peat­edly calls a “de­pres­sion” (or some­times a “low-grade de­pres­sion”). Only fools like the United King­dom’s lead­ers (who re­minded him of the Three Stooges) could be­lieve oth­er­wise.

Yet, rather than a new re­ces­sion, or an on­go­ing de­pres­sion, the US un­em­ploy­ment rate has fallen from 8.6% in Novem­ber 2011 to 5.8% in Novem­ber 2014. Real eco­nomic growth in 2011 stood at 1.6%, and the IMF ex­pects it to be 2.2% for 2014 as a whole. GDP in the third quar­ter of 2014 grew at a vig­or­ous 5% an­nual rate, sug­gest­ing that ag­gre­gate growth for all of 2015 will be above 3%.

So much for Krug­man’s pre­dic­tions. Not one of his New York Times com­men­taries in the first half of 2013, when “aus­te­rian” deficit cut­ting was tak­ing ef­fect, fore­cast a ma­jor re­duc­tion in un­em­ploy­ment or that eco­nomic growth would re­cover to brisk rates. On the con­trary, “the dis­as­trous turn to­ward aus­ter­ity has de­stroyed mil­lions of jobs and ru­ined many lives,” he ar­gued, with the US Congress ex­pos­ing Americans to “the im­mi­nent threat of se­vere eco­nomic dam­age from short-term spend­ing cuts.” As a re­sult, “Full re­cov­ery still looks a very long way off,” he warned. “And I’m be­gin­ning to worry that it may never hap­pen.”

I raise all of this be­cause Krug­man took a vic­tory lap in his end-of-2014 col­umn on “The Obama Re­cov­ery.” The re­cov­ery, ac­cord­ing to Krug­man, has come not de­spite the aus­ter­ity he railed against for years, but be­cause we “seem to have stopped tight­en­ing the screws: Pub­lic spend­ing isn’t surg­ing, but at least it has stopped fall­ing. And the econ­omy is do­ing much bet­ter as a re­sult.”

That is an in­cred­i­ble claim. The bud­get deficit has been brought down sharply, and un­em­ploy­ment has de­clined. Yet Krug­man now says that ev­ery­thing has turned out just as he pre­dicted.

In fact, Krug­man has been con­flat­ing two dis­tinct ideas as if both were com­po­nents of “pro­gres­sive” think­ing. On one hand, he has been the “conscience of a lib­eral,” rightly fo­cus­ing on how gov­ern­ment can com­bat poverty, poor health, en­vi­ron­men­tal degra­da­tion, ris­ing in­equal­ity, and other so­cial ills. I ad­mire that side of Krug­man’s writ­ing, and, as I wrote in my book “The Price of Civ­i­liza­tion”, I agree with him.

On the other hand, Krug­man has in­ex­pli­ca­bly taken up the man­tle of crude ag­gre­gate-de­mand man­age­ment, mak­ing it seem that favour­ing large bud­get deficits in re­cent years is also part of pro­gres­sive eco­nomics. (Krug­man’s po­si­tion is some­times called Key­ne­sian­ism, but John May­nard Keynes knew much bet­ter than Krug­man that we should not de­pend on mech­a­nis­tic “de­mand mul­ti­pli­ers” to set the un­em­ploy­ment rate.) Deficits were not in­creased enough in 2009 to es­cape from high un­em­ploy­ment, he in­sisted, and were fall­ing dan­ger­ously fast after 2010.

Ob­vi­ously, re­cent trends – a sig­nif­i­cant de­cline in the un­em­ploy­ment rate and a rea­son­ably high and ac­cel­er­at­ing rate of eco­nomic growth – cast doubt on Krug­man’s macroe­co­nomic di­ag­no­sis (though not on his pro­gres­sive pol­i­tics). And the same trends have been ap­par­ent in the United King­dom, where Prime Min­is­ter David Cameron’s gov­ern­ment has cut the struc­tural bud­get deficit from 8.4% of po­ten­tial GDP in 2010 to 4.1% in 2014, while the un­em­ploy­ment rate has fallen from 7.9% when Cameron took of­fice to 6%, ac­cord­ing to the most re­cent data for the fall of 2014.

To be clear, I be­lieve that we do need more gov­ern­ment spend­ing as a share of GDP – for ed­u­ca­tion, in­fra­struc­ture, low­car­bon en­ergy, re­search and de­vel­op­ment, and fam­ily ben­e­fits for low-in­come fam­i­lies. But we should pay for this through higher taxes on high in­comes and high net worth, a car­bon tax, and fu­ture tolls col­lected on new in­fra­struc­ture. We need the lib­eral conscience, but with­out the chronic bud­get deficits.

There is noth­ing pro­gres­sive about large bud­get deficits and a ris­ing debt-to-GDP ra­tio. After all, large deficits have no re­li­able ef­fect on re­duc­ing un­em­ploy­ment, and deficit re­duc­tion can be con­sis­tent with fall­ing un­em­ploy­ment.

Krug­man is a great eco­nomic the­o­rist – and a great polemi­cist. But he should re­place his polem­i­cal hat with his an­a­lyt­i­cal one and re­flect more deeply on re­cent ex­pe­ri­ence: deficit-cut­ting ac­com­pa­nied by re­cov­ery, job cre­ation, and lower un­em­ploy­ment. This should be an oc­ca­sion for him to re­think his long-stand­ing macroe­co­nomic mantra, rather than claim­ing vin­di­ca­tion for ideas that re­cent trends seem to con­tra­dict.

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