10 Dec 2011

Let’s Name the New Planet Krugmanus

Economics, Krugman 14 Comments

Krugman routinely mocks those who rely on austerity for European countries, which (he claims) involves growth through exports. To take a recent example from December 9:

European stocks are up today, and I have no idea why. I’m with Felix Salmon — this looks like a disastrous meeting. More austerity, more posing of the crisis, wrongly, as being all about fiscal deficits; no mechanism for ECB funding. Somehow southern Europe is supposed to deflate its way to prosperity, while everyone runs a trade surplus, presumably against that potentially habitable planet we’ve discovered 600 light-years away.

Everyone gets the joke, right? If one country reduces its unemployment rate by boosting exports, then some other country must have a higher unemployment rate because of its increased imports. This is one tactic Krugman used to discredit all of the examples we have of fiscal austerity leading to a quick economic recovery; any time such an example involved a boost in exports, Krugman dismissed it as inapplicable to our current slump. Only if a policy will work simultaneously for every country in the world that is currently in a recession, is it valid in Krugman’s book. Otherwise, he will mock you as relying on a planet 600 light-years away with which all of Earth can run a trade surplus.

But here’s the odd thing. Try reading Krugman’s blog post from today, December 10, which I’m reproducing in its entirety. It sure sounds like Krugman is endorsing currency devaluation as a solution. If I didn’t know any better, that would sound like it’s not something the whole world can implement simultaneously. So here it is:

Let me return for a minute to Kevin O’Rourke’s recent piece on the European summit. Aside from pointing out just how bad an idea the new super-stability pact is, O’Rourke makes an important observation about what the European experience teaches us about macroeconomics:

[Here Krugman is quoting O’Rourke:] One lesson that the world has learned since the financial crisis of 2008 is that a contractionary fiscal policy means what it says: contraction. Since 2010, a Europe-wide experiment has conclusively falsified the idea that fiscal contractions are expansionary. August 2011 saw the largest monthly decrease in eurozone industrial production since September 2009, German exports fell sharply in October, and now-casting.com is predicting declines in eurozone GDP for late 2011 and early 2012.

A second, related lesson is that it is difficult to cut nominal wages, and that they are certainly not flexible enough to eliminate unemployment. That is true even in a country as flexible, small, and open as Ireland, where unemployment increased last month to 14.5%, emigration notwithstanding, and where tax revenues in November ran 1.6% below target as a result. If the nineteenth-century “internal devaluation” strategy to promote growth by cutting domestic wages and prices is proving so difficult in Ireland, how does the EU expect it to work across the entire eurozone periphery?

The world nowadays looks very much like the theoretical world that economists have traditionally used to examine the costs and benefits of monetary unions. The eurozone members’ loss of ability to devalue their exchange rates is a major cost. Governments’ efforts to promote wage cuts, or to engineer them by driving their countries into recession, cannot substitute for exchange-rate devaluation. Placing the entire burden of adjustment on deficit countries is a recipe for disaster.

[Back to quoting Krugman:] Basically, European experience is very consistent with a Keynesian view of the world, and radically inconsistent with various anti-Keynesian notions of expansionary austerity and flexible prices.

The point about nominal wages is especially telling. Ireland has clearly — clearly — faced a massive demand shock; maybe Casey Mulligan will find some way to insist that 14.5 percent of the Irish work force has voluntarily decided to refuse employment, but it’s just not true. And Ireland is supposed to have flexible markets — remember, before the crisis it was hailed as an example of successful structural reform. Yet here’s what has happened to hourly wages in manufacturing in the face of catastrophic unemployment:

[Chart.]

It is really, really hard to cut nominal wages, which is why reliance on “internal devaluation” is a recipe for stagnation and disaster.

The crisis really has settled some major issues in economics. Unfortunately, too many people — including many economists — won’t accept the answers.

So to repeat, I defy anyone reading the above quotation, to deny that Krugman is agreeing with O’Rourke that currency devaluation is the key to ending the Euro crisis. Indeed, that’s exactly what Krugman claims is bad about the ECB–it prevents the troubled countries from devaluing their currencies.

But, in light of Krugman’s first post (quoted above)…devaluing against whom? The inhabitants of Krugmanus, living 600 light-years away?

14 Responses to “Let’s Name the New Planet Krugmanus”

  1. Martin says:

    Bob,

    Krugman wants to diminish the wage differences between the nations in the Eurozone so that the tradeflows reverse. One way is devaluation, this however is not possible for the Eurozone members. What is possible is to raise the inflation rate – this is an argument Krugman has made in the past – a 4% inflation rate would, according to him, go quite a bit to erode the relative wage differences in the Eurozone and this would lead to a reversal in the tradeflows. Everyone devaluing against everyone else would have much the same effect: it would devalue all currencies against goods.

    Did I solve the Kontradiction :P?

  2. Daniel Kuehn says:

    Ah! You should have directly called this a Kontradiction in the title! I actually think this is a legitimate one.

    Which is not to say that Krugman is wrong on the policy.

    What happens when everyone tries to boost GDP by boosting net exports? Net exports don’t change. If you try to boost them the protectionist way, trade falls off. If you try to boost them by just being an awesome exporter than trade increases. But nobody “wins” on the GDP front.

    What happens when everyone tries to devalue? Nobody devalues relative to each other, so you don’t get any net export effects or anything like that – but you do get a lot more money floating around potentially.

    It is a Kontradiction to think everyone can succeed in the nominal goal at the same time. But the failure of devaluing your currency relative to other currencies may have other salutary effects besides just a different exchange rate.

    • David says:

      What happens when everyone tries to boost GDP by boosting net exports?

      Since GDP is really a measure of quantity of money and volume of spending and not real production, then trying to boost the quantity of money and volume of spending by “boosting” net exports, will result in an increase of real net exports on the basis of falling prices. “Real GDP” would rise. Average standards of living would rise. People would be better off. But the quantity of money and volume of spending would not be higher, which means GDP would stabilize, which of course would lead Keynesians into believing the world’s economy is stagnating and/or going through recession.

      What happens when everyone tries to devalue? Nobody devalues relative to each other, so you don’t get any net export effects or anything like that – but you do get a lot more money floating around potentially.

      Maintain that line of thinking when considering a world fiat currency standard from a world central bank issuer. All of the costs that were ignored with multiple world central banks and localized temporary export boosting through devaluation, while all of a sudden become crystal clear.

      Which is not to say that Krugman is wrong on the policy.

      Oh but he is. Inflation is the wrong policy. Just like an indebted household whose members are currently looking for jobs would be wrong to believe that their solution is to counterfeit money, since they could only benefit themselves in this way in the short run, by taking advantage of those who haven’t increased their asking prices, or haven’t increased them by enough to avoid incurring losses from your devaluation, which will just encourage the members of the house to not reduce their debt, perhaps even take on more debt, and not legitimately compete with other households through innovation and productivity, so too is it wrong for a country to solve its debt woes and unemployment through devaluation.

      • Martin says:

        Counterfeiting money? The monopoly supplier is ‘counterfeiting’? I take it the baker is selling fake bread too every time he makes new bread?

        • Daniel Kuehn says:

          I didn’t think it was worth dignifying that with a response, but this is great… fake bread… I’m going to have to remember that one.

          • David says:

            I didn’t think it was worth dignifying that with a response,

            That’s because you are clearly intellectually unable to do so. You’re just hiding behind a veil of supposed civility, and yet you support a very uncivil system.

            but this is great… fake bread… I’m going to have to remember that one.

            Too bad it’s a terrible analogy, since the government doesn’t have a monopoly over bread making, but if they did, and they enforced a necessarily anti-market “bread”, like being made out of clay, then yes, I would consider the government baking more clay bread to be counterfeiting more bread.

            Counterfeiting is relative to a voluntary system, not against what the government defines it to be.

            It’s hilarious how you actually believe that “fake bread” is a zinger you can use. You’re so lost it’s funny.

          • Tel says:

            Bread you can eat, money you cannot… ergo money is not bread.

            It is true that if the baker produces far more bread than there are people to eat that bread, the remainder will have very little value (until sufficient babies are born to consume the surplus which takes a couple of decades).

        • David says:

          All money that is enforced by violence from the state, is counterfeit, because it is counterfeiting real money, that is, money that would exist if there were no violence enforcing one money over another.

          If the government tomorrow decreed that they now have a monopoly on bread production, and they forced everyone to accept their bread, which means their bread must not be valued voluntarily, then it must be because the bread they produce is of no real value, for example suppose their bread was made from clay.

          As the state keeps creating these clay loaves, and calling it bread, then yes, I would call those clay loaves counterfeit bread.

          • Tel says:

            I disagree. The violence is real, so the money is real, because the money is what you offer to get protection from violence.

            It’s a commodity currency, just like gold. In the case of gold, that commodity is prestige (and particularly visible prestige) but in the case of paper money, the commodity is violence (and protection from violence).

            • David says:

              I wasn’t actually denying fiat money was real in the ontological sense.

              I just said it’s a counterfeit of what would exist if they didn’t initiate force to prevent competition. Just like counterfeited money is real in the ontological sense, it’s “fake” according to some standard, which according to the government is their own standard.

              I just consider fiat money to inherently be counterfeit and “fake” according to another standard that transcends my say so, or the government’s say so, or any other individual’s say so, namely, the money that would exist according to free exchange and private property.

    • Tel says:

      What happens when everyone tries to boost GDP by boosting net exports? Net exports don’t change.

      But productivity does change.

      Think about it: nation A is very good at producing apples, but they like to consume oranges. Nation B is very good at producing oranges but they like to consume apples. They both export, they both import and both become better off… and that’s the whole darn purpose of having international trade in the first place.

      But nobody “wins” on the GDP front.

      Actually, they all “win” on the GDP front, because of the additional production that those international trades facilitate. Let’s suppose the Americans offer software that the Taiwanese could not have written themselves, and Taiwan offers computer systems that would be not be affordable if they were made in American factories. Now the Taiwanese can use the software to fine tune their production controls, and the Americans can upgrade their computer systems and thus write better software.

      Again, that;s the whole darn purpose of having trade.

      I agree that if one nation forces exports when there is no genuine justification, then quite likely the resulting forced trades will be of no value to anyone. This is just a restatement of why trade must be voluntary or not at all. However there’s a very good reason for all nations to facilitate trade (and it is extremely important that people understand the subtle but significant difference here).

      • Silas Barta says:

        Actually, I think they can all lose on the GDP front, because the exports and imports cancel each other out, even despite the massively higher standard of living from the greater physical production of apples and oranges.

        In theory, the econometricians could adjust for this but boosting the real GDP numbers on account of (possibly) cheaper monetary prices for apples and oranges, but … *condescending hand gesture*

        • Bob Murphy says:

          Silas wrote: Actually, I think they can all lose on the GDP front, because the exports and imports cancel each other out, even despite the massively higher standard of living from the greater physical production of apples and oranges.

          I haven’t been following your exchanges too closely, but if you’re saying what I think you’re saying, it’s not right. Let’s say we have two countries that originally have a wall in between them, then they remove the wall. Country A exports $1 trillion of apples to Country B, which in turn exports $1 trillion in oranges to Country A.

          If I understand you, Silas, you’re saying the GDPs of the two countries won’t be affected. But that’s not right, because consumption is higher in both countries now (presumably). In GDP = C+I+G+NX, where NX is net exports, it’s true that imports “subtract from GDP.” But that’s because the C and I figures don’t distinguish whether the citizens spend their money on consumption and capital goods made home, or abroad.

          In the limit, if (say) a Muslim country did nothing but raise pigs to sell pork to a neighboring Christian country, which in turn produced nothing except Korans for their Muslim neighbors, then in each country GDP would happen to equal (gross) exports, even though net exports would be zero and hence “wouldn’t contribute” to GDP. I’ve written before on how Krugman I think screwed this up, imputing causality to the accounting tautology.

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