Krugman Doesn't Quite Get It

This blog post by Paul Krugman starts of fairly good, by illustrating one of the imbalances of the U.S. economy by comparing the share of GDP going to various forms of demand in 2007 and the average for 1980 to 2000. Even last year, when residential investment was plunging it was actually still above the 1980 to 2000 average, illustrating just how massive the bubble really was. By contrast business investment, although increasing compared to 2006 was smaller than the 1980 to 2000 average.

But the big difference lies in how consumer spending had a much higher share of GDP, while net exports had deteriorated sharply. From this Krugman concludes that America needs to reduce consumption and increase net exports, but he seems unable to come up with any idea of how this is to be achieved in any way different from the current fiscal and monetary policies.

But what he fails to grasp is that the current policies aim at preventing this adjustment. Both the fiscal stimulus and the aggressive Fed rate cuts is intended to boost consumer spending and thus prevent the necessary adjustment. While the falling dollar will indeed help bring about this, this is more than offset by the demand boosting effects of the rate cuts and the fiscal stimulus. And in any case, the falling dollar will help achieve this correction of imbalances by reducing the purchasing power of American consumers.

What Krugman doesn't realize -or doesn't want to realize- is that it is simply not possible to keep consumer spending and business investments going and at the same time dramatically reduce the trade deficit. In order to eliminate the imbalances you're going to have to accept a recession. A deep recession in this case. No pain, no gain, in other words. Krugman the Keynesian may not like that, but it is nevertheless an objective fact.