Cutting Paul Krugman's Hedge

Ned Flanders: Well do something. This is all your fault. You and your stupid program.

Homer Simpson: Blame me if you must, but don't ever speak ill of the Program! The Program is rock solid. The Program is sound.

Find a failed* government program and you'll find a host of excuses for its failure from its advocates. Perhaps the most popular and difficult to refute, to the satisfaction of its defender, is that the program was simply under-funded; it didn't go far enough. So present a New Deal defender with the irrefutable case that the New Deal's Keynesian fiscal stimulus failed to get us out of the depression (indeed, sound theory predicted it would fail), and one is likely to hear that FDR had the right idea but that the New Deal failed to provide fiscal stimulus adequate to allow consumers to spend us out of the depression.

Enter arch-Keynesian and Nobel Laureate economist Paul Krugman. Just to show what a tough job Barack Obama is taking over, Paul Krugman, a presumptive Obama ally, is criticizing Obama's stimulus plan. Believe it or not, Krugman says Obama's $775 billion plan isn't grand enough: "But Mr. Obama’s prescription doesn’t live up to his diagnosis. The economic plan he’s offering isn’t as strong as his language about the economic threat. In fact, it falls well short of what’s needed."

How does Mr. Krugman know what's needed? The Congressional Budget Office told him: "Even the C.B.O. says, however, that “economic output over the next two years will average 6.8 percent below its potential.” This translates into $2.1 trillion of lost production." Krugman says this $2.1 trillion "output gap" can be filled by fiscal stimulus, i.e. government spending: "Now, fiscal stimulus can sometimes have a “multiplier” effect: In addition to the direct effects of, say, investment in infrastructure on demand, there can be a further indirect effect as higher incomes lead to higher consumer spending. Standard estimates suggest that a dollar of public spending raises G.D.P. by around $1.50."

For the believer in C.B.O. estimates, here's a January, 2008 headline from Reuters: "No recession expected this year: Congressional Budget Office". Even putting stock in C.B.O. projections, it is worth noting that the $2.1 trillion output gap already takes into account $1.2 trillion in deficit spending already projected. Using Krugman's 150% multiplier effect of deficit spending on GDP, then the output gap with a balanced budget would be $3.9 trillion, a 12.7% output gap. Not to worry, this is all the same type of econometric voodoo which has failed so profoundly of late; consider Alan Greenspan’s recent admission that the army of econometricians employed by the Fed failed to warn of the impending real estate implosion.

Zimbabwe is only the most recent example of the repeated failure of Keynesian money pumping. Not only does it fail to bring prosperity, it does incredible damage. The empirical case against inflating to prosperity is rock solid. Is there a theoretical case as well? Krugman’s analysis relies heavily on the purported “multiplier” effect of government spending, so if this effect is an illusion then his case takes a heavy body shot. Frank Shostak concludes his case against the existence of the multiplier effect:

“Likewise loose monetary policy cannot give rise to the expansion of real output. All that it will generate is a reshuffling of the existent pool of real savings. It will enrich the early receivers of the new money at the expense of last receivers or no receivers at all. Obviously then, a loose monetary policy which is aimed at boosting consumers' demand cannot boost real output by a multiple of the initial increase in consumer demand. Not only will loose money policy not lift production, but on the contrary it will impoverish wealth generators…Reality…shows that all the attempts to create something out of nothing lead to economic impoverishment and more misery. In the real world, an artificial boost in demand that is not supported by production leads to the dilution of the pool of real savings and, contrary to the Keynesian view, to a shrinking in the flow of real wealth.”

So against all theory and history, Krugman, Obama, and “economists from across the political spectrum”, advocate fiscal stimulus to boost consumer demand and spend us out of our recession. This will fail. Obama has hedged his play by saying it may take his entire first term to “get there”. Krugman is also hedging his bet so when it all fails, Krugman will be able to say he told us the Obama stimulus package wasn’t big enough, just like the failed New Deal.

The great Nobel Laureate in economics could, according to Bill Anderson, benefit from retaking some freshman-level economics courses. Perhaps a more appropriate form for Krugman’s Nobel Prize Medal would have been, rather than the usual gold, a picture of the gold medal on a piece of paper. Perhaps two trillion of these paper medals would prevent Mr. Krugman from feeling cheated.

* ”Failed” here meaning a failure to achieve its stated ends, programs always succeed in enriching some at the expense of others. See Robert Higgs’ “Myth of Failed Policies” http://www.independent.org/newsroom/article.asp?id=123