Someone familiar with Russian totalitarianism once asked how George Orwell understood it so well without ever having experienced it. It was pointed out that Orwell had been to Eton. Paul Krugman asks how could the guardians of economic orthodoxy all suddenly come out in favour not just of fiscal austerity, which was wrong, but also monetary tightening.
It took bad thinking and bad policy by many players to get us into the state we’re in; rarely in the course of human events have so many worked so hard to do so much damage. But if I had to identify the players who really let us down the most, I think I’d point to European institutions that lent totally spurious intellectual credibility to the Pain Caucus. Specifically:
– The OECD, which a year ago demanded both fiscal austerity and a sharp rise in interest rates, because, well, because. Recently the OECD surveyed Britain, concluded that inflation is likely to decline, unemployment to rise, and that the UK should therefore … continue with fiscal austerity and raise rates. As a correspondent wrote, “What planet are they living on? What planet am I living on?”
– The ECB, which bought totally into the doctrine of expansionary austerity, despite overwhelming evidence that it was false, and proceeded to raise rates in the face of a deeply depressed economy — possibly the straw that breaks the euro’s back.
– The BIS, which called for tighter monetary policy just three months ago, to fight a nonexistent inflationary threat. Did I mention that inflation expectations, as measured by the difference between yields on ordinary and index bonds, have been plunging like a stone?
I haven’t developed a full theory of the sociology going on here. But these organizations should be doing some agonized soul-searching, asking how they got it so wrong while posing as high priests of economic expertise.
I don’t have a fully developed one either, but whenever I see this kind of groupthink, especially in economics, I think of years 8-10 at school. You know that time when the opinion of peer group is virtually irresistible. I recall there were codes about how high one wore one’s belt, and the length of your long pants. Too high or too short was death. Now it would have been possible to wear your pants so long or your belt so low as to lapse into parody, but that was pretty easy to judge. So short of that there was a kind of asymmetry. You could be tolerated (at least for your decisions on these things) or decidedly uncool – not really worthy of the normal considerations due to a human being.
And as one might imagine for a species that evolved on the African Savannah where the most important pronouns were ‘us’ and ‘them’ we’re very attuned to who’s in and who’s out. Indeed, as I read today:
1esearch has found that if you are wearing a wristband, you are likely to discriminate against someone wearing a different color wristband. But if you are tapping your foot in synch with music, you’re more likely to help a person who is also tapping in the same way.
In economics there’s the same kind of asymmetry – and it’s around all those things like fiscal responsibility, no-pain no gain all that stuff. Now it’s not as if those issues shouldn’t get their due. Moreover it’s also true that there are some powerful forces pushing against them. Easing is more popular than tightening and that matters in a democracy. And in normal times these kinds of notions are important. So there’s a role in the eco-system for tough minded no-pain-no-gainedness. But where one needs emergency expansion, as one did in Australia in 2007, or one is in or close to being in a liquidity trap as is much of the developed world, this asymmetry is deadly. It’s horrible to watch the grip on those who are supposed to be trained to be as rational as possible in these situations.
- R[↩]
the Europeans panicked. Government debt to GDP was about 85% for the Euro area and increasing fast. The feeling was there was only so much pump-priming the Europeans could do, and the failure to ignite fast growth started to be blamed on a continued banking crisis for which no end was in sight. I am not sure what Krugman had in mind as the alternative.
Well, it’s true that like most places they had both long and short term issues to deal with which as you know I’ve argued in favour of doing something about institutionally, but Britain managed on well over 100% debt to GDP through much of the 19th Century. If you don’t buy that argument, that still leaves monetary easing.
“Government debt to GDP was about 85% for the Euro area and increasing fast. The feeling was there was only so much pump-priming the Europeans could do …” – Paul
The debt to GDP projections are what is spooking the policymakers, and of course such projections are driven by expectations of falling GDP (and consequent rising deficits). Talk about a self-fulfilling prophecy – for most counties GDP is expected to fall only because of the debt problem, and the debt problem is only a problem because of falling GDP.
Yes there is only so much pump-priming you can do, but that’s a very different proposition to saying either that we’re at those limits (most of Europe is not, and the bond market is telling us that the US is not remotely near it) or that un-priming the pump will make it better. The latter stance is the one Krugman is particularly objecting to.
err Paul,
what does austerity do?
It reduces economic growth and increases deficit and debt. great plan.
You cannot reduce debt or deficits by reducing growth.
It is like the Great Depression never happened. Japan never happened.
Fiscal consolidation is good policy and works just when Keynes says it does, when the economy is growing and what is more we have strong empirical evidence for this through both the IMF and BIS.
We have NO evidence whatsoever austerity works when the economy is very weak and so are other economies
the GDP debt projections were scary yes, and so was the quite realistic prospect of having to bail out the major banks, which is what notched up the public debt in Ireland.
I would say the EU is implementing a form of monetary easing. The ECB is buying up bonds from commercial banks and there is a good chance it wont get its money bank. More monetary easing is probably underway.
No the Europeans panicked because they were told if they did not implement austerity measures bond yields would increase.
Well they increased anyway so they got pain bit with no gain as Krugman said would happen and anyone else who has studied economics.
No Ireland never did have to bail out the banks as they did.
Still having a depression must have been worth it!
ps. It is a common trap to think of the European debt crisis as a euro crisis. The euro is doing fine. In fact, it is almost too strong and could with some devaluing.
Paul floating currencies depreciate only fixed currencies devalue!
homer,
I am just explaining the European position, not defending it. If i were in charge I would have pushed for the ECB to (temporarily) take over the major banks holding so much toxic debt. The way i would have done it was to make a deal with the big governments involved (German, French, etc.) that the ECB could buy the shares at a very low price, whereby those governments in turn would commit on not bailing out their banks independently.
Homer,
nope. The word devaluation is not as constrained as you think. Definitions of it differ. As one website put it, it is simply “a decrease in the spot price of a currency. Often initiated by a government”.
Paul, Firstly the Europeans only have to turn their heads north to know how successfully deal with toxic bank assets.
Secondly whilst websites might Universities do not, at least good ones do not.
A devaluation is a changed from one fixed price to another.
in a floating exchange rate it is changing all the time. governments do little. Central banks do something, sometime successfully such as the Swiss and mostly not.
Still, who really knows?
http://marginalrevolution.com/marginalrevolution/2011/09/the-luck-of-the-irish.html
err Pedro,
the Irish quarterly GDP figures are notoriously volatile.
All the growth happened because of net exports. Domestic Demand fell again.
Not a good omen given present events
GDP is still well below levels in 2008
If that is good luck leave me well alone from it.
Love the title of this post. Very droll.
“but Britain managed on well over 100% debt to GDP through much of the 19th Century”
The obvious problem with all of these comparisons to other times in history is that the population of most of Europe is either stagnant or already going into decline (and rapidly aging). Even solutions like Germany implemented like working to 70 are not going to help with that much, since it is hard to see people’s productivity being especially high at that end of their lives, let alone their level of risk taking in terms of setting up new businesses, creating new ideas etc. .
Actually Conrad OECD research sine the late 90s has your assumption wrong.
You should become a Manager. They have assumptions based on no evidence to bias them against older people working.
“Actually Conrad OECD research sine the late 90s has your assumption wrong.”
Are you saying that the OECD suggests that people over 65 are likely to have high workforce participation rates, high rates of risk taking, and are most likely to do the most creative work of their lives? Good luck to their research.
If you look at the psychological literature, then what you find is that for things like science, the peak age in terms of the best things you will do depends on your field, but for things like physics, it’s very young (i.e., most people do their best work before 40 — just look at Nobel Prize winners). Given this, I thought it was really no surprise that companies like Apple, Microsoft, Google, and Facebook (and almost every tech company can I think of), were all started by people who were well under 60. Although, perhaps my sample is biased.
Is it just me, or is this one of the great phrases? And Nick, did you invent it or borrow it?
Conrad I am saying their productivity is as high as 25 year olds as the OECD found out a long time ago.
The only reason why they do not have high participation rates is because Managers have ideas similar to you which have no evidence to back them up.
gee even the Australian Government simce Bronyn Bishop was Minister has been saying this as well given what is happening to the age of the working population here.
“Conrad I am saying their productivity is as high as 25 year olds as the OECD found out a long time ago.The only reason why they do not have high participation rates is because Managers have ideas similar to you which have no evidence to back them up”
What countries do people over 65 work in? If you look at Japan, for example, where people do, and where people are also exceptionally healthy thanks to eating good food all their lives, low rates of alcoholism etc., and where there are less cultural stereotypes than here (I believe), then what you find is that older people keep on working but in reduced roles.
Look, I’m not against older people working at all (I’d like to see more of it), and I’ll believe that for some subset of jobs, the productivity of many older people is not much different to the normal population (probably higher than certain unreliable groups). However, it just isn’t reality to think that the proportion of people that are going to want to work full time at 70 or 75 is going to be the same as less than 65. This is for a number of reasons, some of which I agree are due to cultural stereoptypes, but some which are not, not least of which includes ill health and people not wanting to work once they have enough money to retire. It also isn’t reality to think that these people are going to take the same risks as other groups (which is confirmed by data in numerous domains), because, apart from biological reasons that affect risk taking, I doubt too many 70 year olds want to go broke taking those risks. I certainly wouldn’t.
Back to the original question, my other real point was that if I have a debt of 150% of GDP, obviously if I think I will have twice the number of people in 30 years time to pay it off, it is going to be much easier to pay off than if I think I will have 20% less.
Shucks David – that was me.
Nicholas it is a nice bit of phrasing!
I think ‘debt’ crisis is not quite the right phrasing; feel that Galbraith’s 1930s phrase, ‘Psychic wealth’ crisis/collapse, is a better metaphor for right now.
I think Nick’s insight is completely correct. Like confirmation bias, it is a natural part of being human. Krugman illustrates the latter nicely at the link provided by Pedro.
He of course illustrates the importance of group adhesion very strongly in every third or so post when he is excoriating the bad faith and immorality of whoever has latest disagreed with him.
Those things make him a rather bad advocate of the economic point, because Krugman has a vendetta against austerity and would quite possibly rather read Ayn Rand than admit that austerity had or could ever work. This is because you can’t belong in his group unless you believe in bigger socialer-democrater government according to the Krugman version of Keynes.
Patrick,
There’s no doubt that Krugman is strongly partisan, though he grew to this from a position of broad bi-partisanship before Bush II’s time in office. But you’re completely wrong to paint him as some crazy expansionist. He understands as well as anyone the importance of fiscal and monetary rectitude in normal circumstances. There’s simply no history of his being particularly lax on these matters in normal times. Indeed, part of his outrage is the uniquely irresponsible approach to conservatism by the American right – with their penchant for starving the beast and leaving the mess to the grown-ups to clean up after they’re gone.
wot Nick said
Krugman , unlike his critics, almost always uses evidence to back his analysis.
This paper quite shows Keynes was right and the classicals bereft of clothes.
People who criticizes Krugman for saying one thing about Reagan, Bush’s fiscal policies and his stance now merely show their ignorance of when one should use fiscal policy and when one doesn’t.
In this Krugman is a classical Keynesian.
Nick, I would really appreciate your thoughts on Tyler Cowen’s comments on Krugman on Ireland, as set out here (Pedro’s link above). Is Tyler just playing tall poppy , or is Krugman just falling victim to always being right?
Your comments or those of any of the other numerous people here with more economics in a little finger than I will ever have are very welcome.
Oops meant to repeat the link here!
Patrick, a few things on Ireland,
Quarterly GSDP figures are notoriously volatile so one should never make a firm statement on them.
GDP ONLY rose because net exports rose. domestic demand actually fell again.
given the main countries Ireland export to this scenario is not looking too god
Even if there are NO revisions GDP is still much lower than in 2008.
Only way to reduce debt is to introduce a depression which makes both debt and deficits higher. Way to go
Hi Patrick,
I’ve always thought that Ireland would do better than most of its PIGS brethren because it’s so small and export oriented. So, with a larger traded sector to GDP its easier for it to deflate and it’s likely to pick up more relatively from each percentage point of cost reduction. (The even more trade exposed Hong Kong and Singapore seem to be able to manage quite substantial internal deflations with short sharp recessions to keep their alignment with the US$.)
Also a bit like us, Ireland seem to be quite keen on the idea of themselves as an economic success and so prepared to suffer for it to get back there (as we might be prepared to if we were in trouble – though that’s pure speculation and highly dependent on the quality of leadership at the time – which I think we’d both agree hasn’t been too flash of late).
Since Krugman’s in a public debate it might have been wiser for him to point out what I’ve pointed out above (if he agrees with it). I certainly never took him to be saying anything very different from what he says he meant – that austerity will work eventually.
Presumably Krugman thinks that austerity was a bad idea for Ireland – that there were better ways out of the crisis for it. I don’t know enough to judge, but I also think that Cowen’s claims have a bit of ‘gotcha’ about them. He has been wise enough to add some weasel words of his own. “No one is calling Ireland a “success,” nor should we be committed to the view that Ireland can survive the coming storm of eurozone defaults.” So he seems to be having a bob each way himself.
Thanks Nick, I did get the feeling that Tyler was being a bit ‘gotcha’. But it is a discredit to Krugman that, reading (ok skimming some of) the pieces cited I find it very very likely that he thought that Ireland would be rooted by Austerity and now doesn’t appear to want to say so. of course I am not the fairest judge either.
Much appreciated!
In many ways Ireland is a sideshow because it’s driven by open economy effects. You’ll recall that Keynes’ General Theory was set out in a closed economy – for the very good reason that the world at the time was going through the great depression and the world is a closed economy. The fact that small countries get an easier way out is cold comfort given the impossibility of everyone taking the same route. It’s very scary what’s happening and it’s amazing how quickly the mood has changed from expansion in 2008 to contraction now. This is after there was quite good evidence that expansion worked!
I didn’t always agree with them but I always thought the CIS was a good part of the intellectual ecosystem in Australia – and in many ways the best think tank we had (not saying a lot). But I’ve been very disappointed not so much at their disagreement with standard Keynesian economics, but with their sloganeering against it. They haven’t really engaged with it, and set out a coherent response. They’ve simply rehearsed a small government agenda against such measures. (Which doesn’t address the point that these were temporary expansions of government for very specific and – arguably – well thought out justifications – calling for equally well thought out positions if one was to object to them.)
Come to think of it, can anyone point me to anything written by a right leaning think tank against expansion that isn’t just a rehearsed bunch of slogans?
And Krugman responds, mainly by pointing out that Ireland is far from out of the woods.
Also, as far as I can see he acknowledges that Ireland had to do austerity and do seem to be making it work, but insisting that they still could have let their banks fall.
All said he seems to miss the point which is not that Ireland is a golden story yet but that he cited it as a disaster and yet it is doing better than the countries he recommended not follow its example.
I’m not sure I follow you. You say Ireland is ‘doing better than the countries he recommended not follow its example’ Which countries. One of Krugman’s examples is Iceland which he argues defaulted (largely because its problems were so bad it had no choice) and yet has done comparatively well – given how badly it was hit.
And I think we all agree that Ireland shouldn’t have guaranteed its banks in the way that it did.
And I’ll never understand why, when bailouts occur, the shareholders are not liquidated. With the resulting state acquired equity being sold off at some appropriate time. But there you go, it takes all sorts.
Economic science mandates fiscal austerity. Anyone who doesn’t understand that doesn’t understand economics. Nick and Paul. You’ve just got to learn the material. Its not acceptable to be in the industry and to maintain this sort of terminal ignorance.
Happytalk: that’s a howler saying that Nick Gruen doesn’t understand economics!
My 2c is that austerity is the macroeconomic equivalent of self-disembowelment. Argentina (and perhaps Iceland?) showed that default actually ended up being a far better option.
Stiglitz describes the idea that at some point an economy undergoing austerity measures will turn around as betting recovery on the Confidence Fairy. Frankly under most circumstances I’d be disinclined to invest in a country which is running down its infrastructure.
(Or are you better at economics than Stiglitz too?)
Look, economics is a very inexact field – as you can see from the range of highly qualified experts saying contradictory things – so if you have a claim to The Absolute Truth you’re an ideologue, not an economist (and thus should probably consider refraining from saying peep when the grown-ups are around).
Nick @31:
*tumbleweed, wolf howling in distance*
“Happytalk: that’s a howler saying that Nick Gruen doesn’t understand economics!”
Its not a howler its a fact. He thinks that the capital destruction of deficits causes economic expansion. He believes in the pure voodoo of the IS-LM curves.
Dan you do know that Nick was part of this “stimulus plan” don’t you? Few peoples economic ignorance has been more publicly displayed. We are talking about people who actually think that Keynes knew what he was talking about.
That is ignorance.
I was on the taskforce that audited the BER – I collaborated on the *Economic Stimulus* chapter, based on some work on multipliers done by an independent consultancy. Man, that was a good program that achieved its macro policy goals admirably. Not perfect, of course, but what the heck is?
No it was a program based on economic ignorance. The people involved were all so ignorant they did not know the difference between GDP and business revenues. No-one involved has ever come up with the tiniest evidence for the Keynesian multiplier, and when they think they have done so its always on the basis of confusing GDP with spending. Now you have to learn the material Dan. Or you will continue with your economic vandalism out of pure ignorance.
“….based on some work on multipliers done by an independent consultancy.”
They used GDP didn’t they? Yes they did. Which meant they produced spurious false positives for deficit government spending leading to increased private spending. Which they would not have done were they not powerfully ignorant. The other problem is that were there shown to be a Keynesian multiplier (which has never been shown), it would be wholly useless information from a public policy standpoint. Since the reality is that we can hit any private sector business revenue target we aim at, by a combination of new cash injection and a reserve asset ratio.
Yes, what an awful recession we’re in… wait.
The kicker is, even when people denigrate the good sense of the Australian fiscal stimulus, they often say the Chinese fiscal stimulus made it unnecessary. I don’t believe they’re correct, but ultimately it amounts to an acknowledgement that maintaining aggregate demand, even if it originated in China, was important in keeping the Australian economy afloat. Present company excepted, I’m sure.
You’re an ideologue who would sooner have seen the Australian construction industry go south, with a whole lot of terrible flow-on effects, than to grant that Keynesianism sometimes provides useful policy prescriptions.
Do you have anything useful to contribute, or just ahistorical sloganeering?
“powerfully ignorant” – I like that!
“wholly useless information from a public policy standpoint” – uh, keeping people employed.
No Dan they didn’t keep people employed. They threw thousands of people out of work. You don’t have the data to show they increased employment, because they didn’t.
Learn the material. Your ignorance is not helpful.
Deficit spending throws people out of work directly. Your statistics would show this clearly enough if you weren’t mixing up GDP growth with economic activity. Business spending with GDP. Employment growth with GDP growth.
Here we see the role of ignorance where you can conflate a single metric with a range of matters that are not the same as this metric. You can only do this because you have no idea of the subject at hand.
Happytalk,
Isn’t it interesting, then, how we had deficit spending, and far lower than predicted unemployment?
Not to mention the interviews with the small contractors and subcontractors who worked on the BER program – who said things like, but for the BER, we’d have had to let staff go, or close up shop entirely?
There’s no serious debate that fiscal multiplier effects do exist and make a difference on the ground.
That you’re not convinced by Keynesianism is fine – but that you reckon that you know more than everyone else (when in fact you’ve made amply clear that you are being extremely selective about what you think might work and might not at the outset) isn’t “science” – a word you mentioned – at all.
It appears you think that obfuscation and abstraction more important than what’s happening in the real world.
Have a read of this: http://michael-hudson.com/1999/09/the-use-and-abuse-of-mathematical-economics-2/
I don’t suppose I’m going to change your opinion, but if you considered the possibility that you don’t have a monopoly on The Answers – especially given that what you’re saying has SFA empirical support – that would be nice.
“Isn’t it interesting, then, how we had deficit spending, and far lower than predicted unemployment?”
No you are just being willfully idiotic. All you have to do to get less unemployment than predicted, is to predict high unemployment. Clearly you were not the person to be auditing such a gargantuan failure and orgy of wealth destruction as the BER.
Once again, they threw thousands of people out of work, and your statistics would show this if you weren’t totally ignorant of the subject. On the other hand your stats, cannot show that they created jobs. Because they didn’t.
Dan,
Austerity will always work (to some – often considerable extent – for small open economies). Providing their austerity outstrips others they can grab a larger share of the world market. This is more painful if the small open economy can’t devalue its currency easily against its trading partners, but can still be effected by reducing costs and prices (competitive deflation).
But austerity can be a pretty ugly story in a closed economy – which is what the world is – at least where there are powerful endemic forces of contraction. Presumably we could have liquidated our way out of the Great Depression. But how long would it have taken and at what cost.
Throw in politics and you’ve got a really nasty situation. My understanding is that the Great Depression helped some nasty things get going in Germany.
Yeah. Treasury just picked an unemployment projection out of thin air. Just made it up! Those crazy kids.
Of *course* unemployment went up. It was a global economist downturn for Chrissakes. It didn’t go up by all that much, and it would have gone up by a whole heap more but for deficit spending, which is a) what Stiglitz said and b) the experience of countries that weren’t in a position to undertake fiscal stimulus.
This is pointless. But I commend the Hudson paper to you.
“Yeah. Treasury just picked an unemployment projection out of thin air. Just made it up! Those crazy kids.”
Yes that is what they did Dan. Now attempt not to be a moron. Clearly you were not competent to audit this failure.
The way you get “less unemployment than predicted” is very easy. You start off be predicting high unemployment. Now the fact of the matter is your statistics don’t back up the lie that the stimulus program created employment. Because it threw people out of work.