Krugman Yet Again

Krugman wrote a post in his blog yesterday that starts off by wondering whether current economic policy is stupid or evil, and then asking why we need to choose. Indeed. It can, of course, as he does not proceed to suggest, be both at the same time.

He says that “problem of maintaining adequate aggregate demand is going to be very persistent,” which I think is a masterpiece of understatement given that wages are declining and the government really doesn’t give a shit about that, and goes on to say that “monetary policy could no longer do the job of stabilizing the economy” as if it was ever able to do that in the first place, given all of the bouncing around that our economy has historically been subject to.

It's also a bit odd to think that demand is something that needs to be created, rather than something that happens by itself. Sort of like making someone love you. It either happens or it doesn't.

He then makes the profound observation that “if monetary policy is assigned the task of discouraging people from excessive borrowing, it can’t pursue full employment and price stability,” because full employment and price stability require excessive borrowing and cannot be achieved without it, you know. What is he smoking, because I want some of that good stuff.

He then poses a dreadful thought, asking, “And here’s the worrisome thing: what if it turns out that we need ever-growing debt to stay out of a liquidity trap?” Hello? The world is out here Doctor Krugman. Are you just now figuring that out?

He follows that with his favorite hobby horse, higher inflation, saying that, “One answer could be a higher inflation target, so that the real interest rate can go more negative. I’m for it!” So if you were thinking about saving for retirement, forget it. Paul Krugman wants you to work until you physically can no longer do so, at which point your kids will borrow money to take care of you. That will work fine, though, because inflation will eventually reduce their debt to somewhere in the neighborhood of five cents, while their kids borrow money to take care of them.

"Another answer could be sustained, deficit-financed fiscal stimulus. But, you say, this would lead to exploding public debt! Actually, no – not if the real interest rate is persistently below the economy’s growth rate, which it will certainly be if it’s persistently negative. In that case the government can run a primary deficit even while keeping the debt-GDP ratio constant – and the higher the level of debt, the higher the allowable deficit."

And here we have the famous “debt only matters as a percentage of GDP,” which is one of the biggest and stupidest lies of all time. GDP is not a measure of wealth, it is a measure of cash flow, and not a particularly accurate one at that, and comparing debt to cash flow is a financial absurdity. Debt is offset against assets, wealth, not against cash flow.

If I pay you $50 to mow my lawn, and you pay me $50 to mow your lawn, according to Paul Krugman we can borrow about $90 between us because we have created $100 of GDP. We have not created a single dollar of wealth; I am out the $50 I paid you and enriched by the $50 you paid me, and you are in the same boat. But that $90 debt is offset by that totally imaginary and meaningless $100 GDP.

If we repeat the process the following month, we can increase our joint debt to $180 because we have increased our GDP to $200. Despite the fact that we now owe $180 instead of $90, we are not any deeper in debt because we still only owe 90% of our GDP. How long can we repeat this before the bank quits lending us money?

“Debt only matters as a percentage of GDP” is saying that you can borrow $90,000 because you are spending $100,000 per year. We don’t care about your income, we don’t care what assets you have, we don’t care how rich you are. Your income might be only $50,000, but since you are spending $100,000 per year we will allow you to borrow $90,000.

Think, too, about the last part of Krugman’s statement, “the higher the level of debt, the higher the allowable deficit.” The more you owe, the more you can spend above your income. The higher your debt, the faster you can create additional debt. That is utterly absurd on the face of it. Only a crazy person would say that. Or an economist.