Liberal thinkers, Paul Krugman most notably, realize that advanced economies are unlikely to undertake the massive fiscal stimulus they favor. That war is probably lost. But with a major policy victory out of reach, they are taking some comfort in apparently winning the intellectual fight. Flaws have been found in the famous Reinhart-Rogoff anti-debt study. And at least in Europe, politicians are apparently backing away from more austerity. As Krugman uncharitably puts it, “What has happened now, however, is that the drive for austerity has lost its intellectual fig leaf, and stands exposed as the expression of prejudice, opportunism and class interest it always was.”
Krugman, shorter: My opponents are not just wrong, they’re evil.
Hey, whatever sells newspaper, I guess.
But even if one concedes a) there is no magic debt level that suddenly saps growth, and b) current debt levels — at least in the US — are sustainable in the near term, does that necessarily lead to what Professor Paul and the Krugmaniacs advocate: “above-normal government spending to sustain the economy” until private-sector spending grabs the baton?
It does not.
1. Fiscal stimulus is no free lunch. Higher debt levels today increase the required level of taxation tomorrow, and higher expected future tax rates reduce real-time incentives to invest. And politicized, crony capitalist spending creates distortions, such as when a favored company or sector gets a government subsidy and some less-connected competitor does not.
2. The Krugman model doesn’t seem to be matching reality. True, real GDP growth has averaged only 1.4% over the past two quarters, but it actually accelerated in the first three months of this year. And private-sector GDP — excluding government consumption and investment — grew 4.0% in the first quarter and has averaged 3.0% over the past two quarters. That’s about what it did from 1983-2007. Not only is the private sector growing at trend, but private job creation is averaging 200,000 month.
Falling government output is what’s tamped down overall growth. Government has subtracted from GDP for 10 of the last 11 quarters. Yet the private sector — the bit of the economy that creates “actual consumer-relevant value,” as economist Tyler Cowen puts it — continues to trudge forward despite tax and spending austerity.
Economist Scott Sumner: “The sharp slowdown predicted by the Keynesians failed to occur. But they are so convinced by the accuracy of their model that they simply assume that a sharp slowdown occurred because by God it should have occurred. I really can’t understand how any thinking person could take Krugman’s “proof” of Keynesianism seriously.”
3. For some mysterious reason — and about this we can only speculate — Krugman continues to play dumb and act as if only fiscal stimulus can deal with economic shocks that push growth below potential. Market monetarists, on the other hand, argue that monetary easing can offset fiscal drag even when interest rates are near zero. That’s the playbook the Fed has been awkwardly and inefficiently attempting to run. Economist David Beckworth: “Fiscal austerity has been happening in the US economy since about mid-2010. And yet, the Fed has kept nominal GDP growing on a remarkably steady growth path (albeit, below its pre-crisis trend path). This performance is even more remarkable when you consider that there have been other negative AD shocks buffeting the U.S. economy.”
Rather than Stimulus 2.0, a better economic formula would be (structural tax and spending reform) + (monetary easing) + (targeted programs to deal with the long-term unemployed) = an end to the New Normal.