10 Jun 2010

A Krugman Kontradiction?

Economics, Financial Economics 7 Comments

In which the author does his best impersonation of Scott Sumner…

I am really really trying to understand Krugman on his recent jihad against fiscal austerity proponents. (See this for example, when Krugman begins eating his own. His point is, “Hey, I’m not being partisan, I’m saying everyone is dumber than me.”)

Of course as an Austrian, I think there is a solid argument to be made for raising interest rates; so yes I can come up with a “model” in which tight money and tight fiscal policy is the right thing to do, notwithstanding high unemployment.

But I am open to the possibility that Krugman is right, and that using conventional mainstream models, there is no such case. That wouldn’t prove to me that Krugman’s colleagues are bozos, it would prove that their intuition is better than their formal models.

Yet I think I might be giving Krugman too much credit. For check out this post:

Some thoughts on the fiscal austerity mania now sweeping Europe: is anyone thinking seriously about how this affects the rest of the world, the US included?

We do have a framework for thinking about this issue: the Mundell-Fleming model. And according to that model (does anyone still learn this stuff?), fiscal contraction in one country under floating exchange rates is in fact contractionary for the world as a whole. The reason is that fiscal contraction leads to lower interest rates, which leads to currency depreciation, which improves the trade balance of the contracting country — partly offsetting the fiscal contraction, but also imposing a contraction on the rest of the world. (Rudi Dornbusch’s 1976 Brookings Paper went through all this.)

Now, the situation is complicated by the fact that monetary policy is up against the zero lower bound. Nonetheless, something much like this transmission mechanism seems to be happening right now…

This is Klassic Krugman. Look at the parts I’ve put in bold above. In order for Krugman to make his point in this particular blog post, it’s necessary that when European countries rein in their deficits, this will lower interest rates. Yes, he admits this step in the argument is a little tricky because of the zero-bound right now on interest rates, but he waves his hands and says it doesn’t affect his argument.

Yet, I am confident that if I spent an hour, I could come up with at least five Krugman posts from the last year, in which he accused other economists of being liars and fiends if they suggested that rising budget deficits would lead to higher interest rates. (Here’s one, I could come up with four more no problem.)

So this is Klassic Krugman: He can make some particular complication be decisive, in order to blow up somebody else’s argument when he doesn’t like that guy’s policy conclusion. But, if Krugman needs to ignore that complication in order reach Krugman’s desired policy conclusion, then it’s fine to safely set it aside for the moment.

What do you think kids? Fair or unfair? (Talking about me in this blog post.)

7 Responses to “A Krugman Kontradiction?”

  1. Randy_Bobandy says:

    I’m a little confused. If lower budget deficits depreciate the currency, does that imply that the fiscal multiplier for government spending is lower than the multiplier for private spending?

  2. Ash says:

    I’m curious as to what Krugman would think would happen to interest rates in the US and EU if both the USG and all the European economies decided to balance their budgets together, right now.Does he think interest rates would implode into some economic black hole?

  3. von Pepe says:

    Great Catch!

    That second bold sentence is a classic krugman escape hatch. Like the one on the housing bubble.

    krugman says McCulley says the only way out of that recession is to inflate the housing bubble.

    I, krugman, want out of the recession (imply housing bubble promotion).

    I, krugman, never said inflate the housing bubble – McCulley did.

  4. david says:

    Yup, there’s nothing like sound government finance to weaken a currency. (KIdding)

    Generally, I try to ignore Krugman. I find I have to expend more effort to satisfy myself he’s wrong than his arguments warrant. Like many people who, consciously or unconsciously, work backward from the result they prefer, his arguments can be inconsistent and confused. Sorting out his arguments isn’t worth it – it doesn’t advance my understanding.

    One of my favourites was when he said, awhile back, “You’ve got John Taylor arguing for permanent tax cuts as a response to temporary shocks, apparently oblivious to the logical problems” even though a) Krugman had called for a permanent increase in the money supply in response to “temporary shocks” (on the basis that unless individuals expect the increase in the money supply to be permanent, it will not be succesful in creating inflationary expectations) and b) Keynesian types always oppose temporary tax cuts as stimulus because if the temporary tax cuts are known to be temporary, they will have little or no effect on expected “permanent income” (and thus little or no effect on consumption). Bottom line is that, in the consumption-driven Keynesian world view, only permanent tax cuts can have a stimulative effect. Thus, it was silly for Krugman to argue that there is a logical problem with using permanent tax cuts to address “temporary shocks”.

    I can understand why you feel you need to take him on, I guess.

  5. D says:

    You’re just way too polite when you call someone out.

  6. Daniil Gorbatenko says:

    In this post Krugman also contradicts his constant claims about the world being in an awful liquidity trap.

    According to the liquidity trap logic, fiscal contraction should lead to deflation (currency appreciation), not depreciation as he claims in this post.

  7. Daniel Hewitt says:

    Here is the comment I left on his blog (awaiting moderation):

    Professor, where is the recovery from the multi-trillion Keynesian stimulus? You and Brad may want to rethink your views, instead of constantly slinging mud at everybody who is not a hydaulic Keynesian, as it’s quite possible that the recession is the cause of reduced spending, not the effect.