Thursday, November 28, 2013

End this Depression Now

I recently read "End this Depression Now" a 2012 book by Paul Krugman about our current economic problems and what to do about them.  I thought it was fairly good although I do not share Krugman's liberal politics.  Krugman's books are more balanced and less polemical than his NYT newspaper columns making them more palatable to me.  Despite the title most of the book is devoted to discussing our current problems and how we got into them.  Less space is devoted to Krugman's ideas for fixing things.  Perhaps because, despite Krugman's protestations to the contrary, he realizes they are nonstarters politically.

Krugman's diagnosis is that our current sluggish economy reflects an overall lack of demand.  There are idle resources but businesses are unwilling to hire people and increase production because they fear (with good reason) that they will be unable to sell the resulting goods and services.  I find this plausible.  A competing explanation cites structural problems, that the economy is set up to produce the wrong things and that time is needed retrain workers and refit factories.  I don't  find this convincing.  If overall demand was adequate but not matched to supply you would expect to see shortages developing and prices rising for those goods and services in strong demand as well as idle capacity in areas of weak demand.  But for the most part this isn't happening.  Now structural problems could become a problem as the economy improves.  I am not convinced that estimates of current capacity generated by naive extrapolation of pre-crisis GNP trends are realistic.  But I don't think structural problems are currently a binding constraint.

I find Krugman's explanations for the origin of the lack of demand and ideas for fixing things less convincing.  He appears to believe that the economy has multiple equilibrium conditions and that although the economy is currently in a unfavorable equilibrium condition (into which it was pushed by the financial crisis) there is also present a preferable full capacity equilibrium.  So all that is needed is temporary government actions to push the economy into the more favorable equilibrium where it will remain by itself without needing continuing support.  For my part I doubt this more favorable equilibrium actually exists (under current conditions) making policy attempts to push the economy into it futile and potentially dangerous. 

One point of disagreement is whether the lack of demand is a chronic condition.  Certainly there was a temporary aspect, the financial crisis panicked people into trying to increase savings (or reduce debt) and due to the well known "paradox of thrift" this leads to a drop in demand.  But the acute phase of the financial crisis is long past, people are no longer panicked but demand remains depressed.  I think this reflects an underlying structural problem which needs to be addressed.  Krugman dismisses my favored explanation briefly in a paragraph on p. 83.

For example, one popular story about inequality and crisis--that the rising share of income going to the rich has undermined overall demand, because of the shrinking purchasing power of the middle class--just doesn't work when you look at the data.  "Underconsumption" stories depend on the notion that as income becomes concentrated in the hands of a few, consumer spending lags, and savings rise faster than investment opportunities.  In reality, however, consumer spending in the United States remained strong despite growing inequality, and far from rising, personal saving was on a long downward trend during the era of financial deregulation and rising inequality. 

I find this unconvincing.  Personal saving is measured on a net basis which can hide a growing imbalance as part of the population saves more and more while another part spends more than their income and goes deeper and deeper into debt.  This can maintain demand for a while but isn't sustainable indefinitely.  Eventually the indebted portion of the population reaches their borrowing limits and is forced to cutback on consumption while the savers continue to try to save leading to a drop in demand.  This looks to me a lot like conditions before and after the crisis point. 

Krugman has two main ideas for improving the economy, pushing up the inflation rate and a temporary deficit financed surge in government spending.  Both seem politically difficult at present which in my view is just as well as I find them uncongenial.

The rationale for increasing inflation is that this would allow additional cuts in the real interest rate (which is currently constrained by the inability to reduce nominal interest rates below zero, "the zero bound").  But I am unconvinced that any benefits would exceed the costs.  Krugman suggests a relatively benign sounding increase from 2% to 4% but it is unclear why this would be enough to have a significant effect.  Perhaps an increase to say 12% would be needed which sounds a lot less benign.  In any case, as Krugman acknowledges, an increase in the inflation rate also has large distributional consequences favoring debtors at the expense of  savers.  So having a lot of savings myself I am not inclined to support increased inflation.

The rational for increasing government spending is to increase overall demand encouraging businesses to expand.  I don't doubt it would have some such effects in the short run but am less convinced they would be sustainable.  As noted above while Krugman believes temporary deficits would be sufficient to push the economy into a more favorable equilibrium I am not convinced.   A political issue is what to spend the money on, there aren't that many uncontroversial and clearly temporary projects for the government to fund.  Krugman points out that crisis imposed budget problems led state and local governments to lay off many workers (deepening the crisis) and argues that this could have been prevented by increased federal aid to local governments.  But while this might have been a good idea several years ago it is entirely unclear that federal aid to hire all those workers back is a good idea now. There are other problems, some of the increased demand will be reflected in increased imports.  This could significantly reduced any benefits to the US economy.  US policy cannot really be evaluated in terms of purely domestic effects. 

Krugman also discusses Europe's troubles.  He attributes many of them to the formation of Euro zone with which I agree, the Euro was clearly a mistake.  But it is unclear how to fix things, as Krugman states unraveling the Euro would be very costly but there are also serious problems with keeping it as it forces an inappropriate uniformity of policy throughout the Euro zone.

In summary this book is a reasonable explication of conventional liberal thought about the economy.  However it is not all that original, I didn't find it to offer a lot of fresh ideas which I hadn't encountered before.  Another issue is the political discussion (which speculates about the outcome of the 2012 elections) is a bit dated.  Nevertheless it is reasonable introduction to the issues from a liberal point of view.

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