Paul Krugman explains that he was right and Evil Righties were wrong about the response to the financial collapse of 2008. But the Times delivers a lovely correction of a Freudian slip, and Krugman continues to wear his Big Government blinders in contradiction of his own earlier analysis.
Correction: May 2, 2014
An earlier version of the web summary with this column pointed out that few economists saw the fiscal crisis coming. The crisis should have been referred to as a financial crisis.
Let's switch to Krugman's ongoing tax-cut denialism of the logic of his own arguments. From the recent column:
...since the fall of Lehman Brothers, basic textbook macroeconomics has performed very well.
In what sense did economics work well? Economists who took their own textbooks seriously quickly diagnosed the nature of our economic malaise: We were suffering from inadequate demand. The financial crisis and the housing bust created an environment in which everyone was trying to spend less, but my spending is your income and your spending is my income, so when everyone tries to cut spending at the same time the result is an overall decline in incomes and a depressed economy. And we know (or should know) that depressed economies behave quite differently from economies that are at or near full employment.
For example, many seemingly knowledgeable people — bankers, business leaders, public officials — warned that budget deficits would lead to soaring interest rates and inflation. But economists knew that such warnings, which might have made sense under normal conditions, were way off base under the conditions we actually faced. Sure enough, interest and inflation rates stayed low.
And the diagnosis of our troubles as stemming from inadequate demand had clear policy implications: as long as lack of demand was the problem, we would be living in a world in which the usual rules didn’t apply. In particular, this was no time to worry about budget deficits and cut spending, which would only deepen the depression. When John Boehner, then the House minority leader, declared in early 2009 that since American families were having to tighten their belts, the government should tighten its belt, too, people like me cringed; his remarks betrayed his economic ignorance. We needed more government spending, not less, to fill the hole left by inadequate private demand.
What Krugman can't bring himself to write is that cutting taxes can serve as well as increasing government spending. The gist - if the tax cuts are spent, then it represents a government funded boost to demand; if they are saved, they help repair household private sector balance sheets by substituting public for private debt.
Why is recovery from a financial crisis slow? Financial crises are preceded by credit bubbles; when those bubbles burst, many families and/or companies are left with high levels of debt, which force them to slash their spending. This slashed spending, in turn, depresses the economy as a whole.
And the usual response to recession, cutting interest rates to encourage spending, isn’t adequate. Many families simply can’t spend more, and interest rates can be cut only so far — namely, to zero but not below.
Does this mean that nothing can be done to avoid a protracted slump after a financial crisis? No, it just means that you have to do more than just cut interest rates. In particular, what the economy really needs after a financial crisis is a temporary increase in government spending, to sustain employment while the private sector repairs its balance sheet.
To be fair, Krugman resisted the notion in the quoted piece that cutting taxes could lead to balance sheet repair, so his denialism is consistent. he provided more on the private debt problem here:
Unfortunately, the economy didn’t come roaring back. Why?
The best explanation, I think, lies in the debt overhang. For the most part, even those who correctly diagnosed a housing bubble failed to notice or at least to acknowledge the importance of the sharp rise in household debt that accompanied the bubble
And I would argue that this debt overhang has held back spending even though financial markets are operating more or less normally again.
Yet tax cuts that helped reduce that private debt bubble wouldn't speed a recovery?
How much do tax cuts and spending raise GDP? The widely cited estimates of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.
But by Jan 11 "pretty good" had changed to "ineffective":
First, Mr. Obama should scrap his proposal for $150 billion in business tax cuts, which would do little to help the economy. Ideally he’d scrap the proposed $150 billion payroll tax cut as well, though I’m aware that it was a campaign promise.
Money not squandered on ineffective tax cuts could be used to provide further relief to Americans in distress — enhanced unemployment benefits, expanded Medicaid and more.
Whatever. I puzzled over Krugman's notion that temporary tax cuts don't spur permanent long-term demand but temporary increases in spending do back in the day. A week later I scratched my head over his insistence that putting more money in people's pockets by way of a helicopter drop (or, heaven forbid, a tax cut) could not be stimulative but extending unemployment insurance could be. And (IIRC, after some emailing to intermediaries) Krugman got pushed back to a modest endorsement of payroll tax cuts.
Left unaddressed is the mix of spending versus saving when the Feds hand out money to the states to boost demand. Krugman is confident that tax cuts to "the rich" will simply be saved rather than spent and hence provide little stimulation. But economist John Taylor of Stanford found that states and municipalities tried to save today to smooth their budget problems over the next several years:
Individuals and families largely saved the transfers and tax rebates. The federal government increased purchases, but by only an immaterial amount. State and local governments used the stimulus grants to reduce their net borrowing (largely by acquiring more financial assets) rather than to increase expenditures, and they shifted expenditures away from purchases toward transfers. Some argue that the economy would have been worse off without these stimulus packages, but the results do not support that view.
More on that here:
The money sent to the states, meanwhile, didn't really increase infrastructure spending. If a state already had a light-rail project under way, it just borrowed less and used some of the federal money instead -- you didn't see more light-rail projects.
Manipulating fungible cash amongst varied short and long term accounts is a bedrock of state and municipal finance in this country; the ideas that sending Federal money to a state (even with earmarks) will force them to spend "that money" on a project rather than re-jiggle all their other accounts so that they spend and save as they want is naive.
Hmm. The dog barks, the day passes...