25 Nov 2010

Paul Krugman, Liquidationist

Financial Economics, Krugman 16 Comments

In the spirit of Thanksgiving, I am not going to accuse Krugman of all sorts of perfidy. I genuinely want one of his defenders to explain this recent post.

Krugman is arguing that the cases of Ireland and Iceland show that the types of remedies he has been suggesting, work out much better than the remedies suggested by his small-government critics. Here’s an excerpt:

[D]espite epic irresponsibility on the part of its bankers, on a scale that makes Irish bankers look like Jimmy Stewart, at this point Iceland actually looks a bit better than Ireland.

I wrote about the surprising resilience of Iceland a while back. Since then, Ireland has had a bit of growth, while Iceland had a modest setback in the first half of 2010 (partly thanks to the volcano)…

Slightly worse (but within measurement error) GDP performance in Iceland, but substantially less bad employment performance. And don’t get me started on Latvia and Estonia.

Oh, and while the IMF is demanding that Ireland cut minimum wages and reduce unemployment benefits, its mission to Iceland praised the “focus on preserving Iceland’s valued Nordic social welfare model.”

What’s going on here? In a nutshell, Ireland has been orthodox and responsible — guaranteeing all debts, engaging in savage austerity to try to pay for the cost of those guarantees, and, of course, staying on the euro. Iceland has been heterodox: capital controls, large devaluation, and a lot of debt restructuring — notice that wonderful line from the IMF, above, about how “private sector bankruptcies have led to a marked decline in external debt”. Bankrupting yourself to recovery! Seriously.

And guess what: heterodoxy is working a whole lot better than orthodoxy.

So yes, “What’s going on here?” Is Krugman saying that it was the fuddy-duddy austerians who were saying, “The government needs to assume all debts in the banking sector,” while it was the bold Keynesians who were saying, “Nah, just let the banks fail, and bankruptcy court will handle it”?

Maybe that’s how the chips fell when it came to recommendations for Ireland and Iceland, but that sure as heck wasn’t how things played out in the U.S. No, Krugman & Co. were saying capital injections into the big banks were crucial. Austrian-types were saying, “Let the big banks collapse. That won’t destroy assets, but instead will simply recognize reality. Bankruptcy courts will reallocate the remaining assets into the hands of more responsible institutions.”

I am sure that’s what we were arguing, because at the time Tyler Cowen told us we were being naive and that bankruptcy would take too long–hence the need for TARP.

(P.S. If someone wants to provide links, I’ll update this post. I told my son I “wouldn’t work” today, and this is borderline working, even though I derive much pleasure from criticizing Krugman.)

16 Responses to “Paul Krugman, Liquidationist”

  1. Mike Sandifer says:

    Bob, the key term is “devalulation”, which Austrians certainly don’t approve of. That makes everything else Krugman writes consistent.

    And when it comes to TARP, it’s easy to imagine better ways to save us from disaster, but it was much better than nothing. If you buy the Friedman argument that letting money supply fall by 1/3 as a similar portion of banks collapsed caused the Great Depression, how much worse might it have been had the top 18 or so lenders responsible for almost 70% of domestic lending collapsed? I don’t want to know the answer to that question.

    • bobmurphy says:

      I don’t buy the Friedman argument. There was much worse deflation–whether in money supply or prices–in 1920-1921 than in any 12-month period of the Great Depression.

      How does the devaluation make it consistent? Krugman never said, “The government should inject capital into the banks, but only because it’s unwilling to devalue.”

      • Mike Sandifer says:

        With respect to Friedman, he also blamed the Fed a great deal for the ’20-’21 recession, citing rapid interest rate hikes, with the economy improving as they started taking them back down in the latter of ’21.

        More generally, there were many differences between this recession and the Great Depression, such that the comparison isn’t even relevant here. It’s something we can certainly go back and forth on, if you like.

        The point about devaluation is that it’s okay to have some austerity and more of a hands off approach to bank failures as long as there’s something like a devaluation to pick up the economy. For example:


        Krugman’s consistent here.

        • bobmurphy says:

          Mike, you are focusing on the two things that I am not talking about here. I want you to show me where Krugman EVER said that the US government should let the big banks go bankrupt, as opposed to bailing them out in some way.

          • Mike Sandifer says:

            My point is the mention of bankruptcies by Krugman in the blog post above is not inconsistent with prior points he’s made about devaluations allowing for more flexibility with fiscal and general economic policies.

          • Some_Guy says:

            Krugman never said the government should let the big banks go bankrupt, because it shouldn’t. That would lead to panic, big time. He DID say they should be seized, which is equivalent ( sort of ). http://krugman.blogs.nytimes.com/2008/09/20/no-deal/

  2. Jonathan M. F. Catalán says:

    I’m sure that Krugman would argue that private debt needs to be replaced by public debt (deficit spending).

    • Desolation Jones says:

      Outside of avoiding austerity, I haven’t really heard him suggesting large deficit spending as a solution for the those crisis euro countries. He blames wages going out of wack relative to other countries like Germany. Being on the euro, they lost their ability to devalue in order to offset their high wages. Hayek made a similar argument about how Britain going back to the gold standard in the 1930s made their wages too high to be competitive in the world market so they needed to devalue in order to lower real wages.

      Actually, I’m not sure if Krugman has ever suggested a solution other than some combination of leaving the euro and defaulting. Well, more of a prediction than suggestion really.

      • Jonathan M. F. Catalán says:

        His argument in regards to Germany has always been that Germany has had some of the highest net federal spending out of any European country.

        • Desolation Jones says:

          I’m referring to the PIIGS. (I should have been clearer) Germany is not part of that crowd. Although he likes Germany’s work sharing program, he hasn’t really attributed their relative success to their government spending either. He says Germany has done well mostly because they avoided the housing bubble, thus their wages weren’t fueled by the boom. Since he thinks their high uncompetitive wages is the main problem for the PIIGS (mostly export countries), I’m not sure how deficit spending would solve that, although he might think it could help a bit. I don’t know. I haven’t seen him suggest large fiscal stimulus when talking about Spain, Greece, and such at least. When the austerity topic comes up, he’s usually trying to drive a point about how it doesn’t improve “market confidence” more than anything else.

  3. Desolation Jones says:

    Krugman wanted a Swedish style temporary nationalization of the failing banks in the US.

    Also, do your own homework for the debate. I’m on to you!

    • bobmurphy says:

      Right, so he would fall into the “orthodox” camp according to his latest blog post. And yet, the reader would have thought Krugman wasn’t in favor of the government guaranteeing the big banks.

      • Desolation Jones says:

        I don’t get how you can’t tell the difference between nationalization and bailing out banks. Shareholders will be cleaned out and CEOs would be fired. The only thing Krugman wants to guarantee is deposit accounts and has never suggested otherwise.

  4. AP Lerner says:

    Mr. Murphy: I’m curious. If letting the big banks collapse would not have destroyed assets, but simple recognize reality, then how do you explain companies like AT&T and Constellation nearly defaulting on their obligations because capital markets were so frozen after the failure of the smallest IB (Lehman)? I mean, it’s very fair to say that capital markets would have been that much more troubled had C and BAC failed as well, right? Would you chalk up the default of AT&T as just reallocating misallocating resources because they could not roll their CP?


    Constellation Energy had to sell itself to the French just to stay alive because, again, capital markets were frozen.


    Also, as someone else pointed out, it’s factually inaccurate to say “Krugman & Co. were saying capital injections into the big banks were crucial”. Krugman was calling for full blow Swedish style nationalization.

    • Bob Roddis says:

      I would think that the followers of the various statist religions such as the Keynesians and Chartalists should answer the opposite question first. They are the ones who believe in an alternate reality of aggregates and an alternate statist morality where the SWAT teams are not constrained by any respect for the rights of individuals. If the big banks collapse, the concrete, the steel, the machines and brain-power still exist but will have different owners. While certain contract rights would be extinguished or modified, do the real-world assets actually disappear, go poof in the night, if big banks are allowed to collapse?

      Further, I’d like the statists to explain why they think their aggregates are real and why they think the state and its SWAT teams are not constrained by morality.