Paul Krugman: “We Have Always Been at War With a Bloated Housing Sector”
Usually I’m pretty good at seeing how Krugman isn’t actually contradicting himself, but instead is engaging in mere Kontradiction–where he twists the dials on something that could plausibly go either way, in order to always come down on the side of more government activism on an issue. It’s not that his decision to turn the dial one way or the other is outrageous on any given issue, but rather that his calibration of the dials isn’t random, or guided by how he actually feels on the issue–it matters where it will lead him on that particular policy issue, for that particular blog post.
But with this one, even I am stumped. Let’s set the context: For years now, Krugman has been blasting the people who have argued that this recession is caused by a need to reallocate resources from one sector to another. Very recently, I wrote a full-blown response at Mises.org, trying to show Krugman that yes indeed, the construction sector was shrinking more than manufacturing and services. This was necessary, because Krugman had tried to show that the declines were across the board: According to Krugman, the problem was a general lack of Aggregate Demand; this had nothing to do with sectoral imbalances, the way Arnold Kling or the Austrians were claiming.
Okay, now let’s change the subject. Suppose we stop talking about the recession per se, and instead talk about optimum currency area and why the Very Serious People are idiots about the euro, and Krugman (as always) has been right all along. In this case, here’s how Krugman describes our current crisis:
The disadvantages of a single currency come from loss of flexibility. It’s not just that a currency area is limited to a one-size-fits-all monetary policy; even more important is the loss of a mechanism for adjustment. For it seemed to the creators of OCA, and continues to seem now, that changes in relative prices and wages are much more easily made via currency depreciation than by renegotiating individual contracts….
But why should such adjustments ever be necessary? The answer is “asymmetric shocks”. A boom or slump everywhere in a currency area poses no special problems. But suppose, to take a not at all hypothetical example, that a vast housing boom leads to full employment and rising wages in part, but only part, of a currency area, then goes bust. The legacy of those boomtime wage increases will be an uncompetitive tradable sector, and hence the need to get at least relative wages down again.
So how do we reconcile this? Is Krugman saying that the housing boom led to rising wages in concentrated pockets of Europe, but not in concentrated pockets of the United States?
Note well, when discussing the Austrian diagnosis of the United States, Krugman (to my knowledge) has never said, “Yes, the Austrians are right that relative wages need to fall in construction and housing in particular, and that workers need to flow out of states like Nevada and into other areas of the country that didn’t boom so much during the good years. However, their recommended solution is just too painful; I have a better way to fix the problem that they’ve correctly diagnosed.”
No, Krugman has repeatedly said, “The Austrians are crazy. The data don’t show any disproportionate impact from housing at all. Unemployment isn’t higher in the housing boom states, and wages aren’t changing at different rates in construction versus other industries.”
(Of course I’m paraphrasing in the above, but that is definitely what he’s been saying. Go to my article linked above, and follow the links if you don’t believe me.)
So, did Europe have a totally different experience during the housing boom during the mid-2000s than the US did? Or, did Krugman have no problem citing the obvious impact of the housing boom on relative wages and sectoral resource flows, when he was discussing optimum currency area, and there was no obvious stimulus spending at stake?
Krugman: “The disadvantages of a single currency come from loss of flexibility. It’s not just that a currency area is limited to a one-size-fits-all monetary policy; even more important is the loss of a mechanism for adjustment. For it seemed to the creators of OCA, and continues to seem now, that changes in relative prices and wages are much more easily made via currency depreciation than by renegotiating individual contracts….”
So I guess, then, the United States shouldn’t have a common currency but each state should have its own to allow for more flexibility and to avoid a one-size-fits-all monetary policy.
Well Krugman has a response for that. I’m not saying it’s legit, just that I know what he would say. But, I don’t see how he can say that the housing bubble caused specific pockets of Europe to have wage increases that now need to come down, but that nothing like this happened in the United States.
The main problem with a housing boom is not constructing too many new houses. It’s the increase in value of existing houses, followed by sudden collapse. After the price collapse many agents have to deleverage. But some people spending less doesn’t automatically force other people to spend more. The central bank has to provide the necessary incentive.
Why should anyone have to spend more. The increase in saving is entirely justified and should be matched by an increase in investment.
Investment is spending.
Too many new houses were built precisely because inflation increased the market price of them.
Why?
“For years now, Krugman has been blasting the people who have argued that this recession is caused by a need to reallocate resources from one sector to another. Very recently, I wrote a full-blown response at Mises.org, trying to show Krugman that yes indeed, the construction sector was shrinking more than manufacturing and services. “
The new housing component of the boom is exaggerated: many of the mortgages in the 2000s were merely refinancing and home equity loans, and the money obtained from the debt not used for new housing construction at all, but to pay credit card debt down or purchase more consumer goods.
In the 2000s the economic effect of the subprime loans (such as liar’s loans or NINJA loans), where people used their houses as ATMs, was an asset bubble in housing, from which exotic CDOs were created.
The economic effects – essentially caused by consumer loans – are clearly very different from the alleged distortions of capital structure imagined in the ABCT. Even if we assume that alleged unsustainable capital structure distortions occurred, they would have been swamped by effects coming from consumer credit expansion to asset bubble speculation, the financial effects of banks loading up on CDOs, MBSs, and CDSs, and then the financial crisis and debt deflation.
LK, as the typical Minsky-ite, treats the concept of economic calculation like Kryptonite and avoids it like the plague. LK insists that economic calculation has nothing to do with the ABCT or Austrian analysis. It allegedly only concerns command economies with no price system at all. I’ve been beating this dead horse for quite awhile, but this is the primary basis for LK’s critique of all things Austrian. This phony “analysis” allows him and the other Minsky-ites to declare that the foolish actions of the public in the face of fiat funny-money loans is caused simply by the general inherent foolishness of the public and thus requires FIRM AND WISE GOVERNMENT REGULATION (by the Minsky-ites and their ilk). LK claims:
The economic calculation problem – if you are talking about the debate between Mises/Hayek and various socialists – is about the viability of command economies with no price system.
This is a stupid red herring: Hayek’s ABCT is about alleged price distortions/forced saving in economies where the vast majority of production is done privately, not about production in a communist country where all capital goods are owned by the state and production done by central planners.
Bandying the words “economic calculation” around in this context simply shows you’ve got no idea what you’re talking about.
LK is also relying on the fact that fiat credit card debt and fiat home equity loans were not the focus of Mises and Hayek who wrote during a period when those types of transactions did not exist. Thus there were events in the last 12 years that may not have been “classic” ABCT. This is a central “point” of LK’s perpetual attack. But since the fundamental Austrian concept is economic calculation and its distortion by fiat funny money, LK cannot even conceive of how economic [mis]calculation might play out in alternative factual situations because in his “mind”, it does not apply in the bizarre universe of fiat funny money.
I believe Joseph Salerno has addressed these issues here:
http://econ.as.nyu.edu/docs/IO/18508/Salerno_2011April11.pdf
“LK is also relying on the fact that fiat credit card debt and fiat home equity loans were not the focus of Mises and Hayek who wrote during a period when those types of transactions did not exist. Thus there were events in the last 12 years that may not have been “classic” ABCT. “
LOL.. so my critique is valid?
I’ve had the same critique of the “classic” ABCT for 20 years. But it doesn’t get you Keynesians anywhere simply because the problems caused by your schemes are now understood to be even more complicated than originally imagined. Further, the basic Austrian critique that fiat funny money will distort prices and mislead most everyone (especially long term and complicated investments) is still valid in spades and is a point from which you run and hide because it eviscerates all things Minsky.
LOL..no.
“Classic” ABCT is one of malinvestment (i.e. partial relative overinvestment and partial relative underinvestment) caused by centrally planned, anti-market, “funny money” control.
The last time I checked, fiat credit card debt and fiat home equity loans are examples of partial relative overinvestment (the investment that led to the explosion of fiat credit card debt and fiat home equity loans), which of course carries with it a partial relative underinvestment elsewhere (which can appear as a temporal increase in “investment” everywhere).
Hayek and Mises explained the business cycle before the explosion of finance, by considering the effect of central banking on the structure of capital goods. The “classic” ABCT is therefore colored by its place in history. The THEORY of ABCT is not specific, it is not constrained, to just the structure of capital goods however. Mises never tired in pointing out that ABCT is a theory of malinvestment.
You can’t blame him and you can’t fault the theory for not including 2012 modern finance in the “upper stages” concept. He can’t predict the future components of what investment exactly entails. But the same principle of discoordination and distorted economic calculation applies. This is the part that is going over your head. You have to grasp the concept of economic calculation FIRST in order to understand ABCT, and how to apply the theory to a given period of time.
Just because we’re adding new investment types all the time to the structure of production, it doesn’t mean “classic” ABCT is falsified and does not apply to today. It will always apply to the extent that individuals act in a monetary order controlled by a non-market entity.
Like the Energizer bunny, LK can’t stop:
http://tinyurl.com/88w77p7
To be fair, neither do we.
That’s good, because it means more people can see just how destructive and economically fallacious the Keynesian cult really is.
Is there any blog where you don’t end up used as a punching ball?
To be fair you’ve got the face for it
Haha,
You mean the wrecking ball.
No I mean the punching ball.
You on the other hand get you ass kicked in every blog.
Curiously, it looks like Roddis’face.
Wrecking ball. Got it.
—-
I kick ass on every blog I go to. You’re just jealous.
Sure, that’s why you can never sit down
Followers sit.
Leaders stand.
I know you need a leader.
What matters is that idiots like you get their ass kicked in every blog they visit. Morons like Roddis are punching balls.
Does a blog exist where Manmouth does not behave as a 14 year-old punk?
Mises wrote:
“It would be a serious blunder to neglect the fact that inflation also generates forces which tend toward capital consumption. One of its consequences is that it falsifies economic calculation and accounting. It produces the phenomenon of imaginary or apparent profits. . . . If the rise in the prices of stocks and real estate is considered as a gain, the illusion is no less manifest. What makes people believe that inflation results in general prosperity is precisely such illusory gains. They feel lucky and become open-handed in spending and enjoying life. They embellish their homes, they build new mansions and patronize the entertainment business. In spending apparent gains, the fanciful result of false reckoning, they are consuming capital. It does not matter who these spenders are. They may be businessmen or stock jobbers. They may be wage earners.”
LK is committing a “serious blunder”.
“Classic” ABCT does contain over-consumption.
And more:
“…one must realize that forced saving can result from inflation, but need not necessarily. It depends on the particular data of each instance of inflation whether or not the rise in wage rates lags behind the rise in commodity prices. A tendency for real wage rates to drop is not an inescapable consequence of a decline in the monetary unit’s purchasing power. It could happen that nominal wage rates rise more or sooner than commodity prices.”
And more:
“[W]ith the further progress of the expansionist movement the rise in the prices of the consumers’ goods will outstrip the rise in the prices of the producers’ goods. The rises in wages and salaries and the additional gains of the capitalists, entrepreneurs, and farmers, although a great part of them is merely apparent, intensify the demand for consumers’ goods . . . . It is customary to describe the boom as overinvestment. However additional investment is only possible to the extent that there is an additional supply of capital goods available.
“As, apart from forced saving, the boom itself does not result in a restriction but rather in an increase in consumption, it does not procure more capital goods for new investment. The essence of the credit-expansion boom is not overinvestment, but
investment in wrong lines, i.e., malinvestment.”
From Salerno:
“the recession-adjustment process is further prolonged by the fact that the boom has wreaked havoc with monetary calculation, the very moorings of the market economy. Entrepreneurs have discovered that their spectacular successes during the boom were merely a prelude to a sudden and profound failure of their forecasts and calculations to be realized. Until they have regained confidence in their forecasting abilities and in the reliability of economic calculation they will be understandably averse to initiating risky ventures that appear profitable.”
This by itself can explain the prolonged slump!
MF:
Have you seen LK’s latest nonsense, taking Hayek out of context to criticize Rothbard?
http://socialdemocracy21stcentury.blogspot.com/2012/06/rothbard-shoots-himself-in-foot-why.html
All Hayek was saying is that if an entire society is going to institutionalize the fiat funny-money credit machine that we have, pointing fingers solely at the banks is silly. You will all reap what you have sown.
As usual, nothing but incompetent distortion of what Hayek says.
Even W. Block and K. M. Garschina (1996. “Hayek, Business Cycles and Fractional Reserve Banking: Continuing the De-Homogenization Process,” The Review of Austrian Economics 9.1: 77–94) know that Hayek is here offering a defence of FRB:
“But Hayek is not content to exonerate bankers as embodiments of free enterprise virtue. He goes on to offer a defense for their
anti-market activities” Block and Garschina p. 83.
I stick to my original statement applied to fiat and government FRB. Whether Hayek was right to “defend” the bankers in that context is debatable and irrelevant to anything today.
Keep beating the dead government FRB horse, LK.
Since you will not and cannot understand the basic Austrian theory, you spend your entire existence finding small and irrelevant errors in the writingsof Hayek, Mises and Rothbard. They were just human beings after all and wrote basically in solitary against the statist zietgeist and without the help of the internet. Here and there we will find things we do not agree with. So freakin’ what?
As expected, LK is completely clueless of the ANTI-capitalist origins and practice of FRB.
To LK, the fact that FRB takes place in society, somehow makes is consistent with capitalism, despite the fact that FRB is inconsistent with absolute property rights. Capitalism is based on absolute property rights, not the fuzzy “Nobody knows who really owns a present economic claim to that dollar” in FRB.
To LK, if two people “voluntarily agree” to harm a third, then it would be “anti-capitalist” to stop them.
This nobody cultist of Keynes continues to display a contemptible, risible hypocrisy that is only matched by his incredible ignorance.
We’ve already won against this clown ages ago.
At this point, he’s just here for amusement.
Well I think the missing link here is that the housing crash impacted balance sheets and wealth levels which gave us a much broader aggregate demand problem that started feeding on itself and propagating through other sectors.
Surely nobody is under the impression that Krugman doesn’t think sectoral rebalancing and relative price adjustments go on? I hope not. He’s talked a lot about banking being oversized and needing to shrink for sure. But if you’re diagnosing this depression, I think his point is that we have a depression because of a failure of aggregate demand, not just because employment in one sector is readjusting.
The bolded section in the main post leads us to believe that Krugman switched between “sectoral rebalancing is the effect” and “sectoral rebalancing is the cause”.
Well I think the missing link here is that the housing crash impacted balance sheets and wealth levels which gave us a much broader aggregate demand problem that started feeding on itself and propagating through other sectors.
Can we not say that those other sectors that depended on the housing sector were also “Austrian” malinvestments, precisely because they would never have been made had the housing boom not taken place?
The economy is interconnected. There is no missing link of an aggregate demand problem, if we’re talking about investments that were made that depended on the housing boom, and vice versa.
The fact that the fall in employment was so different across different temporal focused trajectories (i.e. construction versus durable goods versus non-durable goods versus retail) shows that the problem of malinvestment wasn’t just constrained to housing. To whatever extent other investments depended on the housing boom (including all those investments that home owners spend their home credit card money on), we should say those were malinvestments as well.
The “housing boom” is not a unique description of the economy. The bubble was spread out to many sectors. The Fed just reinflated the currency and the Treasury bailed out politically connected friends, in time to make history one of a housing collapse only.
If the Fed and Treasury did nothing, then the corrections would have spread to all the other secondary malinvestments that depended on housing, and then to the tertiary malinvestments that depended on the secondary investments, and so on.
Such a problem LOOKS like an “aggregate demand” problem, because spending is declining across the board, but it is really not an aggregate demand problem at all, but an aggregate investment problem. Why would people spend money on the output of investments that should never have been started in the first place? If I lived in a country that contained investments that produced such things as fake dog poop, and Keynesian textbooks, and I chose not to spend my money on them, is the problem here really one of insufficient demand, or just partial relative overinvestment (which is why I don’t spend), and partial relative underinvestment (which I would have spent my money on)?
Surely nobody is under the impression that Krugman doesn’t think sectoral rebalancing and relative price adjustments go on? I hope not.
It’s not about whether they are taking place or not. It’s about whether or not they are the proximate cause for the depression.
But if you’re diagnosing this depression, I think his point is that we have a depression because of a failure of aggregate demand, not just because employment in one sector is readjusting.
Bingo, and the “aggregate demand” story is what Murphy is saying the data doesn’t show. The clear differences of the extent of correction between temporal sectors is not consistent with the “falling aggregate demand” story. For why should demand fall more in some temporal sectors than in other temporal sectors, and do so in the same way every time there is a bust? Could it be that maybe, perhaps, possibly, during the boom there were too many resources and labor allocated to the sectors that suffered the most during the bust, in accordance with how much they suffered, i.e. the more they suffered, the more too many resources and labor were allocated to that sector during the boom?
Why shouldn’t a sectoral readjustment accompany falling aggregate demand?
If you had car trouble, then would it make sense to say that the parts of the car that are malfunctioning, should not cause the overall car from stopping because there are still “good” parts in the car that the bad parts can move into, as if the motion of the car (aggregate demand) should be a given? That the malfunctioning parts can be corrected as the car is being driven?
If you can understand why the above would be silly, then you can understand the common criticisms against ABCT that say sectoral imbalances should not accompany a general economic decline, that a bust in one part of the economy “should” lead to a boom elsewhere.
Problems start with the Keynesians and their use of the term “aggregate demand” which might be a helpful generic statistic if they were to stick to that use. However, the concept then immediately morphs into a generic “lack of aggregate demand” where the supply and demand for finished products are suddenly conceived as generic lumps which might be easily repaired and re-aimed with more funny money and/or deficit spending. In fact, the problem has arisen because entrepreneurs have been misled into supplying either the wrong stuff or too much of the right stuff and the “consumers” now find themselves much poorer than they previously realized all due to previous disruptive Keynesian-style policies. MF has explained that in detail. A new and refined analysis of everyone’s situation needs to occur and Keynesian policies impair and disrupt that new analysis.
Another purpose of the term “lack of aggregate demand” was to distract from the obvious truth that Keynesian policy violates basic principles of private property and limited government and that the Great Depression (like the 1920 depression) was caused by the government, not market failure. The term provides a pseudo-scientific sheen to the looting and shifting of purchasing power and the general resulting control of the populace who, as we all know, are simply too dumb to be allowed to set their own wages and prices. Another purpose of the term “lack of aggregate demand” was to run right past without addressing the essential Austrian concerns about economic [mis]calculation. And the ploy worked magnificently on the practical level.
“He’s talked a lot about banking being oversized and needing to shrink for sure.”
Because in his mind, the wealthy right-wingers control the banking sector and criticizing them works well for his career as “the intellectual bodyguard of the House of Democrats”, to borrow a phrase.
At first, I thought you were wrong to paraphrase “The data don’t show any disproportionate impact from housing at all”, as I can recall Krugman writing about the disparate effects of the housing bubble. Here’s what I found (though I know there are more):
http://krugman.blogs.nytimes.com/2011/05/18/stupid-stimulus-tricks/
However, this appears to be Krugman taking both sides of the issue (disparate effects of the housing bubble only count when it supports his point). From the links in your article:
http://krugman.blogs.nytimes.com/2008/12/27/hangover-theorists/
And also:
http://krugman.blogs.nytimes.com/2008/12/22/southern-discomfort/
Beefcake, we were both right!
Mammouth’s cult has gone explicitly Leninist, which is fine with me.
http://mikenormaneconomics.blogspot.com/2012/06/how-to-stop-revisiting-illogic-of-gold.html
We are Lennonists. You can rattle your jewelry all you want.