We’re not great fans of macroeconomics around here, being of the opinion that this is the half of the subject we know humans are wrong about. Still, it’s worth keeping an eye on what’s being said over in La La Land simply because so many politicians believe this stuff.
At which point Paul Krugman’s new paper. Which could, possibly should, be summed up as “Told Ya So!” Reasonably fairly in fact, because he did rather predict what would happen, before it happened, during the crash. So, well done there, although it’s not entirely necessary to agree quite so effusively as Brad Delong does.
The only thing I can think of to do is to propose two rules:
1) Paul Krugman is right.
2) If you think Paul Krugman is wrong, refer to rule #1.
Do note an important caveat to this. Krugman is an essayist of rare skill, one who has produced more than his fair share of teeth grinding from jealousy around here. He’s equally an exceptionally good economist. Those two make up the Good Krugman. The party political scribe running a column in the New York Times is Bad Krugman. Delong’s proposal only refers to Good Krugman – maybe Delong might not agree with that but everyone else should keep it in mind.
It’s also true that certain things in the paper need further explanation, or could be explained in other ways.
Figure 5 therefore shows a Blanchard-Leigh type comparison for the period from 2009-2013. On
the horizontal axis is the degree of austerity, as measured by the IMF’s estimate of the change
in the cyclically adjusted budget balance as a percentage of potential GDP. On the vertical axis
is the deviation of growth from the IMF’s forecast in the April 2010 World Economic Outlook.
As in Blanchard-Leigh, this comparison suggests multipliers substantially larger than those
estimated from pre-liquidity-trap data, and indeed probably more than one. So the fourth
prediction of the original liquidity-trap analysis is, I would argue, also supported by the
“Austerity” here is something very specific. It’s not what people shout about in the newspapers, whereby starving babies are denied diapers because food stamps have been cut. It’s that spending isn’t enough to stop a rise in unemployment. I know, odd definition, but that’s what the counter cyclical part is doing there. It’s an assumption that spending rises enough so that we don’t in fact have a recession at all. It rather bakes in the assumption that spending does work to prevent or stop recessions. And it’s never going to be true that spending will rise enough to stop them either.
Note very well indeed that this form of austerity absolutely isn’t the modest decrease in the rate of spending increases that the British Government has been doing these past few years. We’re using austerity in a technical, not colloquial, sense.
There’s also this:
What we actually saw, as shown in Figure 3, was an enormous rise in the monetary base, far
larger than anyone initially contemplated. Yet nominal GDP growth and inflation remained low.
The figure also shows strikingly little growth in M2; what growth there was probably reflected,
at least in part, a shift of funds from shadow banking, not counted in the aggregate, to insured
All this was exactly as predicted, although some economists apparently didn’t get the memo.
For example, in 2013 Martin Feldstein described the failure of monetary expansion to produce
inflation as “puzzling,” and insisted that the decoupling was due to the Fed’s decision to pay
interest on excess reserves, which caused monetary base to simply accumulate in the banking
This is true but we can explain it another way. Milton Friedman might have made the same point using MV = PQ. When V changes then large changes in M aren’t going to change (or perhaps will change very much more, depending upon which way V is going) P very much.
However, there’s still a problem here. Which is that imagine that all of this analysis is correct. Monetary policy isn’t all that effective at the zero lower bound, multipliers are above 1. Thus the answer is lots of fiscal policy – more accurately, lots of lovely spending on something great like infrastructure. Hmm, sounds like a plan.
But we’ve still got a problem. We tried that. $800 billion of it in fact. And after a couple of years of looking around we found precisely zero shovel ready projects to go spend the cash upon. That is, the plan still doesn’t work for a reason not included in our model. It simply takes too long to get the permits to go do anything these days. We can no longer throw 30,000 men with shovels into the desert and end up with the Hoover Dam. We’ve got 1 million pages of environmental impact statements and some millions of man hours of public inquiries to get through first.
Amazing as it may seem even though the theory’s just great fiscal policy still doesn’t work. For the amazing reason that governments aren’t very good at spending money.