04 Apr 2014

An Example of Krugman Specifically Endorsing Reduction in Capacity to Boost Employment

Krugman 23 Comments

I’ve still got people in the comments pretty sure I’m mischaracterizing Krugman. So for posterity, here is Krugman explicitly calling for regulations that make firms poorer, arguing that they will boost employment during a liquidity trap:

As some of us keep trying to point out, the United States is in a liquidity trap: private spending is inadequate to achieve full employment, and with short-term interest rates close to zero, conventional monetary policy is exhausted.

This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken windows fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment. Indeed, in the absence of effective policy, that’s how recovery eventually happens: as Keynes put it, a slump goes on until “the shortage of capital through use, decay and obsolescence” gets firms spending again to replace their plant and equipment.

And now you can see why tighter ozone regulation would actually have created jobs: it would have forced firms to spend on upgrading or replacing equipment, helping to boost demand. Yes, it would have cost money — but that’s the point! And with corporations sitting on lots of idle cash, the money spent would not, to any significant extent, come at the expense of other investment.

More broadly, if you’re going to do environmental investments — things that are worth doing even in flush times — it’s hard to think of a better time to do them than when the resources needed to make those investments would otherwise have been idle. [Bold added.]

So this is exactly what I said Krugman had been doing: He isn’t calling for arbitrary reductions in Aggregate Supply (or potential GDP or just “capacity” if you want to remain grounded in the real world and not mainstream models). He’s not pining for earthquakes, or secretly planting rumors of an alien invasion.

However, he really believes his 2011 model with Eggertsson, which says that in a depressed economy with a debt overhang blah blah blah, measures that reduce productivity will actually boost employment and output. So that what would normally be a strike against, say, an environmental regulation–which must be counterbalanced by its ostensible benefits in mitigating climate change damages–now turns into yet another reason to support it.

Last thing: The reason these ozone regulations would reduce capacity going forward is that they are a restriction on the production technology firms are legally allowed to use. So don’t just get hung up on them having to replace existing machinery; that mandate per se doesn’t reduce (potential) GDP, it just means that some of actual GDP is sopped up replacing a machine only because of the regulation. [UPDATE: Actually in a normal economy the replacement of the machinery would directly reduce potential GDP relative to the baseline counterfactual, to the extent that it displaced some private investment. In other words firms have to devote some of their investment just to comply with the regulation, which doesn’t boost their capacity, rather than investing in other things that would have increased productivity next year.]

However, it’s still true that going forward, even with the new machinery etc., firms have fewer options available to them in how they can combine resources to create goods and services. So the regulations permanently reduce Aggregate Supply (or potential GDP, or “capacity”) relative to the non-regulation baseline.

23 Responses to “An Example of Krugman Specifically Endorsing Reduction in Capacity to Boost Employment”

  1. Matt M (Dude Where's My Freedom says:

    I just can’t get past the “idle cash” part. As if these businessmen just have a vault full of gold coins that they go swimming in, Scrooge McDuck style…

  2. Transformer says:

    So now we have established that New Keynsians

    1) Have models where in theory supply shocks would be stimulative.
    2) actually really use these models to propose supply shocks as policy

    Is it fair to ask what in your view is wrong with the models themselves ?

    You initial “Earthquake…” post did indeed indicate that empirical evidence from natural supply shocks showed that output didn’t actually increase in these episodes , but there clearly could be a lot more variables involved in these real-world situations than just a rise in expected inflation and interest rates that appear to drive the theoretical NK models.

    • Transformer says:

      “and fall in expected interest rates”

      • Andrew' says:

        “Is it fair to ask what in your view is wrong with the models themselves ?”

        The assumptions, is the short answer.

        How do you get a backward-sloping demand curve? Deflation, right?

        I don’t think increasing the prices of some things relative to other things fixes a deflation. It seems like it would make it worse. Isn’t that why sticky wages are bad?

        That’s one reason I would be sympathetic to education during recessions.

        • Transformer says:

          I think it is the AD curve that is backward sloping and one reason for this (according to Krugman in that paper) is because in a world where there is a lot of debt a decline in wages and prices causes real debt levels to increase and people to spend less in real terms as a result.

          • Andrew' says:

            That’s a big caveat- that now we are talking about such a special case, especially considering debt deflation is a relatively new tweak to the mainstream model to make it work better. Remember, the story used to be that debt-repayment was just changing hands and neutral.

            I have no problem with toying with models, it seems pretty fun, but it’s a big assumption to assume reality has to conform (and then to mandate policy? whoa boy!) when you are in the very process of tweaking the model.

            Another problem is playing fast and loose with when something is aggregate versus non-aggregate. An earthquake can’t keep all prices high whereas quantitative easing has a shot (allegedly).

            • Andrew' says:

              I can’t be bothered to actually do the equations,

              But forcing a firm to invest in pollution abatement does not create the cash money.

              I know they think people are hoarding cash, but there are other theories on that, mine being that the credit markets just took a huge dump so everyone needs to be able to self-finance. That is way different from an irrational liquidity preference that can be intervened away without consequence.

              • guest says:

                That is way different from an irrational liquidity preference that can be intervened away without consequence.

                Preferences aren’t irrational, they’re subjective to the individual, which is whom the producer needs to satisfy in order to make a profit, if he wants to do so without violence.

                Artificially raising prices by printing money steals purchasing power from later users of the new money, and so it is force.

                When a crash comes, those who have debt aren’t having their debt raised so much as having their artificial source of income relieved from them.

                It’s not a bad thing when a business loses profits which were only higher due to some of their customers being thieves. A reduction in profits from thieves would actually increase profits where it can be had without force.

                The intervention of which you speak does not come without consequence; Rather it comes with misallocations of resources which must be liquidated.

                To your sticky wages contention, I recommend this:

                [Time stamped]
                Answering the Same Old Arguments Against Sound Money | Thomas E. Woods, Jr.

                Also, when wages go down, prices go down for consumer goods, so that your money buys more.

              • guest says:

                *”… when wages go down after a crash”, I should qualify; and when they go down in those industries which were artificially stimulated.

    • Capt. J Parker says:

      The Krugmeister is spot on. In a liquidity trap everything is the reverse of what it should be. Even the Laffer curve is wrong. Here’s the proof:

      Co = subsistence consumption and
      Cm = the marginal propensity to consume
      t = the tax rate
      G=tY + Gd
      Gd = the deficit so,
      Y=Co +CmY(1-t) +tY +Gd +I rearrange to get
      Note the Liquidity Trap Multiplier = 1/(1-Cm)(1-t)
      Clearly as taxes become totally confiscatory (i.e. t goes to 1) Y becomes infinite!
      So, In a liquidity trap the answer is simple. Get Uncle Sam to take all your money and spend it (and go deeply into hock I might add) and everyone can be rich!

    • Ken B says:

      A fair question, and the point is missed by most here. But not by Bob who addressed it in the last para and lst sentence. The long term effects are bad.
      I have high blood pressure and can alleviate it by lopping off a finger and bleeding a while.

      • Bala says:

        and the point is missed by most here

        I am reminded of a saying in Tamil that translates roughly as “Then there was this guy who listened to a reading of the Ramayan all through the night and then asked ‘Is Rama Sita’s paternal uncle?'”

  3. Major_Freedom says:

    I just realized something while reading this discussion.

    Austrianism = Calculation, (individual) planning, entrepreneurship….thinking…reason…MIND.

    Keynesianism = Force, (central) planning, doing something, anything…physicality….materialism…BODY.


    • RPLong says:

      Forgive me, MF, I just can’t resist. (It’s all in good fun.)

      What is the nature of that superior world to which they sacrifice the world that exists? The mystics of spirit curse matter, the mystics of muscle curse profit. The first wish men to profit by renouncing the earth, the second wish men to inherit the earth by renouncing all profit.

      Their non-material, non-profit worlds are realms where rivers run with milk and coffee, where wine spurts from rocks at their command, where pastry drops on them from clouds at the price of opening their mouth. On this material, profit-chasing earth, an enormous investment of virtue—of intelligence, integrity, energy, skill—is required to construct a railroad to carry them the distance of one mile; in their non-material, nonprofit world, they travel from planet to planet at the cost of a wish. If an honest person asks them: “How?”—they answer with righteous scorn that a “how” is the concept of vulgar realists; the concept of superior spirits is “Somehow.” On this earth restricted by matter and profit, rewards are achieved by thought; in a world set free of such restrictions rewards are achieved by wishing.

      • Gamble says:

        I don’t know if Rand( Galt) encapsulated what MF was trying to say? Rand is bagging on wishers or wishful thinking.

        MF is talking about Krugman ilk wanting to control peoples bodies as if slaves. Krugmaistas don’t merely wish, they pull out the guns of guberment and make it so, unfortunately.

        MF care to clarify?

        • Major_Freedom says:

          Keynesians view other people primarily as things that “move.” Since movement abstracted from mind is force, there is no fundamental flaw in initiating force against mind if observed movement qua force declines.

          Austrians view people primarily as things that “act.” Since movement not abstracted from mind is action, there is a fundamental flaw in initiating force against mind if observed movement qua action declines.

    • Gamble says:

      Control freaks.

      Lust for power. Libido Dominandi

      Obviously you cant rule or have much power by yourself so make/join a gang called state.

      “Tutto nello Stato, niente al di fuori dello Stato, nulla contro lo Stato”

      everything for the state, nothing outside the state, nothing against the state

  4. guest says:

    … something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment.

    What is being ignored, here, is the fact that spending and employment can make people POORER, if they are being artificially restricted from being able to spend their money on what they want, and if they are being employed to transform malinvested resources.

    If I COULD have spent my money on a more valued preference, absent government intervention, I am POORER for my spending.

    If I COULD have taken a job, the wages of which were only available because they were stolen from someone else, not only is my employment making others poorer, but it is inherently unsustainable, given that consumer preferences justify some OTHER production process.

    More “Output” and more “employment” does not necessarily equal more wealth. Output is only wealth when it satisfies preferences through voluntary exchanges.

    • Major_Freedom says:

      Violence is more real than thoughts because we can observe movements whereas we can’t observe minds.

  5. Gamble says:

    I think this recent Schiff article is relevant yet tackles the same issue( Keynesian mindset) from a different angle.


  6. andrew' says:

    Probably a hundred times on various blogs I’ve suggested countercyclical labor regulation with not a single response.

    We did however have a president using the crisis to constantly increase labor fixed costs.

  7. Bob Murphy says:

    Transformer et al.: Daniel Kuehn helpfully provided me with this link to show Yglesias spelling it all out.

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