Well I really thought a few weeks ago I demonstrated that you need more than simple accounting to come up with Krugman’s constant assertions that debt reduction will lead to lower incomes. But Krugman writes today, in a post entitled “Death By Accounting Identity“:
Martin Wolf has a somewhat despairing-sounding column this morning, in effect pleading with the Cameron government to admit that the laws of arithmetic must apply. Good luck with that.
If the private sector is seeking to run down its debts, it is hard for the government to do so, too, because everybody cannot spend less than their income. That is the “paradox of thrift”. No, it is not a novel idea.
Here’s a challenge: Could Krugman please spell out this alleged accounting identity? I imagine he thinks the argument goes like this:
(1) A household reduces its debt by reducing spending below its given income.
(2) Therefore, a country on net reduces its debt by reducing spending below its given income.
(3) We can’t be silly and use the fallacy of composition like the Chicago School, Dark Ages economists. We know that income isn’t given, and if everyone reduces spending then income goes down.
However, notice there is a missing assumption:
(2′) Aggregate debt reduction doesn’t increase income through any mechanisms.
Maybe that’s true and maybe it isn’t, but that’s one of the major arguments between Keynesians and non-Keynesians. Krugman and Wolf’s conclusions do not follow from mere accounting. To see a simple example of how aggregate debt reduction can go hand-in-hand with rising GDP and incomes, see my article. Maybe it’s implausible, maybe it violates Keynesian economics, but it certainly doesn’t violate accounting rules.