Monday, November 10, 2008

Krugman, FDR & Keynesian Policies

There is a debate over what kind of Democratic president Obama will be. Some hope (or fear in cases of leftist Democrats) that he will be a moderate like Bill Clinton and Jimmy Carter, while others including me fear (or hope) that he will be a radical that significantly expands government power, like Franklin Roosevelt or Lyndon Johnson.

Paul Krugman, who supported Hillary Clinton in the Democratic primaries, isn't entirely sure of whether Obama will be a moderate or a radical. But he clearly says that he thinks Obama should be radical like Roosevelt. Indeed, in his latest New York Times column and in several posts on his blog, he thinks that Obama should be even more radical than Roosevelt. In particular, he thinks that FDR was too cautious in allowing the budget deficit to expand until World War II.

Several points can be made about this: First of all, his measurement is the so-called "full employment" deficit. That means that the so-called automatic stabilizers (a cyclical downturn reduces tax revenue, while increasing spending on welfare and unemployment benefits without any active political decisions) that Keynesians actually usually celebrate as a big advantage of a welfare state are excluded. But since such alleged stabilizers wouldn't exist in a pure laissez-faire economy, they do in fact constitute a form of Keynesian intervention.

Secondly, as Alex Tabbarok points out, one reason why the increase in the deficit were limited was because first Herbert Hoover and then Franklin Roosevelt implemented significant tax increases (See Greg Mankiw's illustration of tax rates during Hoover & Roosevelt). The increase in government spending was enormous, but only some of that was financed through higher taxes rather than increased borrowing. If Krugman thinks that Hoover and Roosevelt did the right thing with regard to spending, but erred in financing some of it through tax increases, does that mean that he now favors keeping the Bush tax cuts in place?

It should be further noted with regard to this point that direct government spending is usually regarded by Keynesians as superior to tax cuts (especially tax cuts for people with high income) because there is a risk that they might save some of it. So, the Hoover-Roosevelt strategy of raising marginal tax rates and spending it directly could too be considered a form of Keynesian policy.

Finally, Krugman completely ignores (typically enough for a Keynesian) the long term effects of large deficits and high spending. If you study the economic data for Japan during the 1990s you can see that whenever they temporarily accelerated the increase in the deficit it did produce a short-lived upswing. But that upswing soon disappeared, and Japan's once awe-inspiring growth rates fell to the lowest of all industrial economies, as all of its savings were diverted into government bonds, as opposed to private investments. It is interesting to see that he criticizes Roosevelt for tightening fiscal policy in 1937, several years after GDP started growing again. What Krugman apparently advocates are not temporary deficits, but permanent deficits, something which will have a negative effect on growth because of the crowding out effect.

Krugman may have been a good trade economist, but he is not a good macro economist. Too bad he has stopped writing about trade and instead has focused on macroeconomics.


Anonymous Anonymous said...

Amen. He is a pop economist. Kind of like Jim Cramer is to the asset management world.

10:10 PM  
Anonymous Anonymous said...

Krugman is Rothbard's law in action

10:16 PM  
Blogger stefankarlsson said...

Bill, exactly what Rothbard law are you referring to?

10:30 PM  
Anonymous Anonymous said...

Bill refers to Murray Rothbard, "Everyone specializes in what he is worst at."

Libertarian thought with no sense of irony.

10:44 PM  
Blogger Celal Birader said...

why didn't you publish my comment ?

12:33 AM  
Blogger stefankarlsson said...

Celal, I accidentally deleted it. If you want to, you may post it again.

8:13 PM  
Blogger Celal Birader said...

Thank you, Stefan, for giving me another opportunity.

I just wanted to echo the fact that a Nobel prize doesn't necessarily mean one knows everything about economics.

I wanted to give the example that Krugman from about 6 months ago was strenuously arguing that the oil price was "just about supply and demand".

His ignorance was exposed in a post by the "Peak Oil Debunked" blog which went into detail about how price discovery occurs in the oil industry.

Ah yes "details", don't bother me with "details".

Anyway, his analysis required specialist knowledge which Krugman was lacking and hence he was dead wrong as the rapid movement downward since July clearly demonstrated that it was not "just about supply and demand".

8:26 PM  
Blogger Unknown said...

Since when is trade not a part of macroeconomics....didn't you learn that Y= C + I + G + (X-M)???
(X-M) is the net trade balance...

4:28 PM  

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