Paul Krugman: The Deficit is Too Small

[Ad Orientem]

In the interest of offering a view not frequently heard, especially on this forum, I refer the reader to Professor Krugman's latest article in the NY Times.

http://www.nytimes.com/2013/03/11/opini ... ml?hp&_r=0

File this under Devil's Advocate.

[Pointedstick]

Krugman understands the dual private-public nature of our monetary system, but never misses an opportunity to inject his political perspective that the public side should be bigger. He's entitled to his opinion, but I'm of the mind that directing our energy toward making the private sector more productive is likely to pay bigger societal dividends than enlarging the proportion of the economy that's sustained through inefficient, polarizing, politically-directed deficit spending.

Put it this way: Smart fiscal policy involves having the government spend when the private sector won’t, supporting the economy when it is weak and reducing debt only when it is strong.

The problem isn't that Krugman is wrong here; it's that this goal is impossible because government is at the helm. In addition to the political motivations that always complicate these decisions, hindsight makes the ideal times to spend and pull back seem a lot more clear-cut than it seems at the time. If we as investors face difficulty in beating a coin toss when market timing, what makes us think the inefficient, interest-group-beholden government can possibly perform any better?

[craigr]

What a  lot of these guys don't get, or don't want to get, is expanding government spending often causes a ton of unintended consequences that hurts businesses. Sometimes the funds are used to subsidize pursuits that result in making companies less competitive because they will use the funds to white wash over their own deficiencies instead of fixing them. Or it may be used to direct R&D efforts into dead-end technologies and keep scientists from exploring their own directions that could result in major breakthroughs nobody had considered.

In terms of individual liberty, spending often expands the military/industrial/surveillance state in virtually every corner. Local police today have battlefield weapons being given to them. DHS is buying billions of rounds of ammo and armored personnel carriers. Airports now put people through humiliating TSA searches to travel freely. Etc. Then there is the massive expansion of the entitlement state that is creating millions more dependent on government and will expect that entitlement to be there forever. It encourages and expands a growing underclass.

But to the bean counters they get so wrapped up in their ideas that they never seem to think about these and many other outcomes of what happens when you give a large government a blank check to spend on whatever it fancies. The end result is not going to be good for anyone.

[moda0306]

In a balance-sheet recession with a strong demand deficiency, improving the balance sheet of the private sector by running government sector deficits is the right move, IMO.  I know many MR guys agree.  It's one thing if the private sector is in a position to want to invest to improve balance sheets, but aggregate investment doesn't increase when demand is far below current investment capacity.

However, I'm not with PK in that it HAS to be done via spending increases including a lot of make-work.  1) There's plenty of real work to be done (I almost hit a pot-hole that could have ripped the axle off of a monster truck this morning), and 2) Payroll tax cuts work wonderful, IMO.  As long as the spending doesn't create bad moral hazards

I truly believe that while not causing our past depressions, running big government surpluses (private sector deficits) robs the private sector of the "clearing assets" it needs if/when a financial crisis strikes, and exacerbates said crisis.  So many depressions were made worse by a lack of safe assets in the private sector when it came time to delever or adjust after a financial crisis hit.. IMO of course.

[moda0306]

Krugman understands the dual private-public nature of our monetary system, but never misses an opportunity to inject his political perspective that the public side should be bigger. He's entitled to his opinion, but I'm of the mind that directing our energy toward making the private sector more productive is likely to pay bigger societal dividends than enlarging the proportion of the economy that's sustained through inefficient, polarizing, politically-directed deficit spending.

Put it this way: Smart fiscal policy involves having the government spend when the private sector won’t, supporting the economy when it is weak and reducing debt only when it is strong.

The problem isn't that Krugman is wrong here; it's that this goal is impossible because government is at the helm. In addition to the political motivations that always complicate these decisions, hindsight makes the ideal times to spend and pull back seem a lot more clear-cut than it seems at the time. If we as investors face difficulty in beating a coin toss when market timing, what makes us think the inefficient, interest-group-beholden government can possibly perform any better?

PS,

I don't think that last part is as hard as it seems.  If we are in a demand-side crisis where we're far under capacity, reduce payroll taxes and build infrastructure you would have soon anyway until we achieve closer to full employment.  It doesn't matter if it wasn't perfect timing or perfect infrastructure, because we don't want perfect to be the enemy of the good while people sit on their asses unemployed.

This may sound like some kind of "too good to be true" scenario, but there's no free lunch here.  We're asking millions of men and women to wake up early and build us roads and buildings and laying sewer or water.  That sounds pretty miserable to me ... though not as miserable as being unemployed for a long period.

What a  lot of these guys don't get, or don't want to get, is expanding government spending often causes a ton of unintended consequences that hurts businesses. Sometimes the funds are used to subsidize pursuits that result in making companies less competitive because they will use the funds to white wash over their own deficiencies instead of fixing them. Or it may be used to direct R&D efforts into dead-end technologies and keep scientists from exploring their own directions that could result in major breakthroughs nobody had considered.

In terms of individual liberty, spending often expands the military/industrial/surveillance state in virtually every corner. Local police today have battlefield weapons being given to them. DHS is buying billions of rounds of ammo and armored personnel carriers. Airports now put people through humiliating TSA searches to travel freely. Etc. Then there is the massive expansion of the entitlement state that is creating millions more dependent on government and will expect that entitlement to be there forever. It encourages and expands a growing underclass.

But to the bean counters they get so wrapped up in their ideas that they never seem to think about these and many other outcomes of what happens when you give a large government a blank check to spend on whatever it fancies. The end result is not going to be good for anyone.

Craig,

I see what you're saying, which is why I'm only for this kind of fiscal expansion during a recessionary time, don't want it to be military or "boondoggles," for it to be mostly infrastructure and also a good chunk of tax cuts.

So I only half agree (or maybe 65% agree ) with Krugman.  His love for high taxes, spending on make-work, and warm heart towards military expansion are a huge turn off.

Right now, a lack of demand is driving a lack of investment... it's the main "uncertainty" businesses are worried about.  And you can't wave a wand to make people spend confetti they don't have.  People simply need more confetti in their bank accounts, both rich and poor.  How many of your past business ventures happened because the companies that hired you or bought your startup had a reasonably optimistic projection of steady demand for their products?  Without that demand expectation, what else would really have mattered to them?  Taxes? Regulation?  Interest rates?  No.  First comes whether people will buy your $hit, then comes all the other considerations.

[Pointedstick]

If we are in a demand-side crisis where we're far under capacity, reduce payroll taxes and build infrastructure you would have soon anyway until we achieve closer to full employment.  It doesn't matter if it wasn't perfect timing or perfect infrastructure, because we don't want perfect to be the enemy of the good while people sit on their asses unemployed.

This may sound like some kind of "too good to be true" scenario, but there's no free lunch here.  We're asking millions of men and women to wake up early and build us roads and buildings and laying sewer or water.  That sounds pretty miserable to me ... though not as miserable as being unemployed for a long period.

I agree with you. But somehow, whenever it happens in the real world, rather than getting fixed potholes, hydroelectric plants, and high-speed trains, what we actually get is handouts to cronies, backstopped loans to politically-connected industries and naive college students in the liberal arts, and grants to local police for the purchase of automatic rifles and armored vehicles. Let's not forget private prisons, border fences, drones, free cell phones, and targeted grants to government agencies for the production of studies that by total coincidence happen to support whatever the president thinks is a good idea today.

That's why I generally oppose the "more government spending" approach. In theory, it could work great if the money was all spent on hiring people to efficiently build legitimately valuable public works. In practice, all I've seen is the worst possible manifestation of regulatory capture and domestic militarization.

[craigr]

Right now, a lack of demand is driving a lack of investment... it's the main "uncertainty" businesses are worried about.  And you can't wave a wand to make people spend confetti they don't have.  People simply need more confetti in their bank accounts, both rich and poor.  How many of your past business ventures happened because the companies that hired you or bought your startup had a reasonably optimistic projection of steady demand for their products?  Without that demand expectation, what else would really have mattered to them?  Taxes? Regulation?  Interest rates?  No.  First comes whether people will buy your $hit, then comes all the other considerations.

It is chicken and the egg. Government largesse creates artificial demand. If a business owner is smart, they won't build their company around a subsidy that could dry up at any time. So odds are what the business may do is nothing. Just take the money while it is there and wait things out.

Government coming into the market creates just as much, if not more, uncertainty than leaving things alone. Primarily it's because customers come and go in small increments. But government handouts can end almost overnight. It's a very different risk profile in terms of thinking about future revenue.

And again, if the government announces they are spending $1 Billion on making 10,000 new jobs what are those jobs going to be?

Well I know it won't be daisy pickers.

It will be new tax collectors, new DEA agents, new TSA agents, new military contractors, new UAVs, etc.

So regardless of the good intentions, the outcome will be against my personal interests.

[melveyr]

Let's not forget that there are two ways to increase the Federal deficit: spending increases or tax cuts.

I would be in support of a large tax cut if spending remained the same. At the end of the day I just want the government to give out more than it is taking away until the private sectors balance sheets are healthy again.

[craigr]

Let's not forget that there are two ways to increase the Federal deficit: spending increases or tax cuts.

I would be in support of a large tax cut if spending remained the same.

Tax cuts and sustained spending is like matter and anti-matter coming together. They can't exist in the same spot of the universe.

[moda0306]

Let's not forget that there are two ways to increase the Federal deficit: spending increases or tax cuts.

I would be in support of a large tax cut if spending remained the same.

Tax cuts and sustained spending is like matter and anti-matter coming together. They can't exist in the same spot of the universe.

Craig,

What do you mean by that?  I think it's a phenominal idea and one of the areas I think it would be easy to get people to agree from opposite sides.  I think a payroll tax holiday is the best manifestation of that.  It affects workers and especially business owners to a great degree.

However, I think the tax cut talk is tainted by supply-siders (as opposed to "balance-sheet repair-men" like melveyr and myself) by trying to push through things like lower capital gains rates and a "simpler" tax code with lower rates and less deductions (I love this latter idea for the long-term but it's not going to get the economy moving again, IMO).

So we get one side not wanting to do any tax cuts, and the other side wanting to do the wrong kind of cuts & reforms that only benefit people with passive income... errr.. I mean job creators... and nothing gets done.

[craigr]

Fundamentally I just believe the best way for government to repair business balance sheets is to get out of the way. They just cause problems and competent businesses don't need their help.

But the idea that there will be tax cuts and sustained spending is just not going to happen unless there is a *major* economic problem that forces it to happen. Neither would tax cuts and reduced spending happen here (yet). It's just a very rare thing and the only reason it happened in the past is because we were coming out of a major war that was sucking resources out of every corner of the economy. The framework would not have been sustainable after it ended and people wouldn't have put up with it without the major war crisis in their heads.

That's why I think Krugman comparing GDP/Debt ratios after WWII is misleading. The reason the ratios came down is because they had to because things would have just flown apart if they didn't. It wasn't because of some brilliant economic theory to repair the economy. No economy can survive 90% tax rates at the highest, price controls on major goods, and the gutting of your workforce by sending your youngest workers overseas to get shot. It had to end. So comparing the situation to what we have today is wrong.

[Pointedstick]

On a more practical level, the political feasibility of combined tax cuts and rising deficit spending (hopefully on infrastructure rather than strip-search machines and bazookas for police) is low since nobody understands MR. Half the people want high taxes and high spending, the other half want low taxes and low spending. The public consciousness is simply not there to support these kinds of policies.

IMHO, that's one of the big problems with the prospects of government-directed MR-based fiscal policies. They're so "out there" to most people that politicians won't touch it with a ten-foot pole. Warren Mosler even shows this perfectly in his 7 Deadly Sins book where he relates an anecdote about how he explained MR to Al Gore once, only to receive in response an acknowledgement that Mosler was right, but that Gore couldn't advocate for any of those policies because it would be political suicide.

Maybe an enlightened dictator could do it, but I think the prospects for MR-driven policies in a democratically-ruled society are very slim.

[Gumby]

It is chicken and the egg. Government largesse creates artificial demand. If a business owner is smart, they won't build their company around a subsidy that could dry up at any time.

if the government announces they are spending $1 Billion on making 10,000 new jobs

You call it "artificial demand," but without the government jobs, how do you propose those 10,000 unemployed people get their money to buy the things that "smart" business owners are selling? The "smart" business owners aren't going to hire those people just to create their own demand.

[Pointedstick]

It is chicken and the egg. Government largesse creates artificial demand. If a business owner is smart, they won't build their company around a subsidy that could dry up at any time.

if the government announces they are spending $1 Billion on making 10,000 new jobs

You call it "artificial demand," but without the government jobs, how do you propose those 10,000 unemployed people get their money to buy the things that "smart" business owners are selling? The "smart" business owners aren't going to hire those people just to create their own demand.

Those 10,000 unemployed people could, I dunno, learn some in-demand skills and/or relocate to areas with better employment prospects. Just sayin', macro problems can have micro solutions. Not everything requires a government cash dump.

[Libertarian666]

What would HB say about this?
I'm pretty sure it would be something like this: "Government spending is the problem, not the solution".
I can be confident about that, since that is the answer you would get from any Austrian economist...

[Kshartle]

5,000 can dig a hole and the other 5k can fill the holes back up. Maybe I should run for president.

[Gumby]

It is chicken and the egg. Government largesse creates artificial demand. If a business owner is smart, they won't build their company around a subsidy that could dry up at any time.

if the government announces they are spending $1 Billion on making 10,000 new jobs

You call it "artificial demand," but without the government jobs, how do you propose those 10,000 unemployed people get their money to buy the things that "smart" business owners are selling? The "smart" business owners aren't going to hire those people just to create their own demand.

Those 10,000 unemployed people could, I dunno, learn some in-demand skills and/or relocate to areas with better employment prospects. Just sayin', macro problems can have micro solutions. Not everything requires a government cash dump.

Those definitely aren't good solutions for macro problems.

First of all, populations don't just "learn" in-demand skills. It often requires lots of people taking out a loans (i.e. private credit) in order to take the classes to learn those skills — particularly if you want your employer to take you seriously. When private credit is hard to come by, government spending provides needed liquidity for an economy with tight money.

Secondly, if the solution is for everyone to migrate out of areas with poor job prospects to areas with better prospects, you just end up creating ghost towns everywhere. Hardly a solution to the problem at hand.

Let's not ignore the fact that private sector's business profits are largely supported by government deficits...

See: http://pragcap.com/profit-margins-and-t ... ts-deficit

That's just how it works in a debt-based/credit-based economy. Private credit can't do everything.

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[Pointedstick]

So there's nothing that unemployed people can do to improve their situations? Their best hope is to sit around, waiting for the government to boost aggregate demand so optimistic businesses will hire more labor?

[craigr]

You call it "artificial demand," but without the government jobs, how do you propose those 10,000 unemployed people get their money to buy the things that "smart" business owners are selling? The "smart" business owners aren't going to hire those people just to create their own demand.

Show me an example of an economy that was dominated by government supplied jobs and handouts that has been more productive than one where free markets ran things and people figured out their own path to work. These are not easy decisions, but when deciding between two equally bad options (10,000 unemployed vs. 10,000 government subsidized jobs), I'll take the less spending because it has fewer long-term consequences.

Stimulus spending just provides an academic smokescreen for politicians to point to so they can buy votes and protect their pet projects in their districts. It is not doing what many think it is doing and in the long-run it is quite damaging.

[Kshartle]

Ghost towns come about because of misplaced resources due to the market forces being distored by Government violence forces.

[Gumby]

So there's nothing that unemployed people can do to improve their situations? Their best hope is to sit around, waiting for the government to boost aggregate demand so optimistic businesses will hire more labor?

Pretty much. Yes, an individual can take out a loan and learn new skills or move to a place with better prospects. But, that can't really happen on a macro level (not enough credit and problems with local/geographic issues, as well as high real estate demand in places with jobs). Private credit can't solve everything.

Show me an example of an economy that was dominated by government supplied jobs and handouts that has been more productive than one where free markets ran things and people figured out their own path to work.

Nobody said anything about having an economy dominated by government employees.

And you're ignoring the fact that the US government is the world's largest employer — employing 4.4 million people in 2011. The US Department of Defense alone employes roughly 1 in 10 US citizens. That massive government spending finds its way into corporate profits. The fact of the matter is that the private sector would be far less profitable without government spending (see previous chart).

These are not easy decisions, but when deciding between two equally bad options (10,000 unemployed vs. 10,000 government subsidized jobs), I'll take the less spending because it has fewer long-term consequences.

Stimulus spending just provides an academic smokescreen for politicians to point to so they can buy votes and protect their pet projects in their districts. It is not doing what many think it is doing and in the long-run it is quite damaging.

What is so damaging about giving people jobs if the jobs are actually needed by society? We don't need teachers? We don't need people building highways? I don't understand why you think it's productive for people to be unemployed when work needs to be done and people are willing and able to do that work.

[Gumby]

Ghost towns come about because of misplaced resources due to the market forces being distored by Government violence forces.

I'm pretty sure ghost towns happen when companies close down factories (due to lack of demand) or move them overseas. This causes people to have less money in their pockets and they look for work elsewhere as local demand plunges.

[Kshartle]

All credit is private. You can't loan what hasn't been saved. The government doesn't create credit. It steals the value of other people's savings and loans it in unproductive manners because the losses are borne by the public not the individual making the loan.

[Gumby]

All credit is private. You can't loan what hasn't been saved. The government doesn't create credit. It steals the value of other people's savings and loans it in unproductive manners because the losses are borne by the public not the individual making the loan.

Too many misconceptions to start picking them apart. Banks don't loan reserves. The government doesn't loan other people's savings. Too bad you never took the time to understand our modern monetary system.

[Pointedstick]

So there's nothing that unemployed people can do to improve their situations? Their best hope is to sit around, waiting for the government to boost aggregate demand so optimistic businesses will hire more labor?

Pretty much. Yes, an individual can take out a loan and learn new skills or move to a place with better prospects. But, that can't really happen on a macro level. Private credit can't solve everything

"Welcome to Gumby's school of self-improvement! Lesson one: maybe you can pull yourself meagerly towards a better life, but the student sitting to your right probably can't, and the odds are against more than a few of you succeeding. Really, you'd better wait for the government to fix the economy."

You should write a spiritual successor to Browne's How I found Freedom In An Unfree World. Maybe something like How I Came To Realize That Macro Stacked The Deck Against Me And Found Peace Waiting For The Prevailing Conditions To Change.