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I've been following Paul Krugman's blog and columns for a couple years now. He's the only political writer that I read consistently—and even though his blog is called "The Conscience of a Liberal", he's really still more of an economist than a political writer; that is, he has strong viewpoints about politics and policy, but he backs it up with a lot of economic data and theory. I don't agree with him on everything—he supported Hillary over Obama in the primary—but generally the things he says make a lot of sense (though sometimes they are a bit hard to follow when he gets wonkish). It's frustrating, though, how seldom his views seem to filter out into the mainstream media and popular mindset. Perhaps it's just that he's wrong, and I should venture outside the Krugman bubble and read some opposing viewpoints; I would happily accept suggestions for blogs that are similarly grounded in data and science but draw different conclusions. But I also sometimes worry that he just doesn't speak plainly and emphatically enough for his (often counterintuitive) positions to get noticed and understood. So, in the interest of public education, I'm going to try to summarize his stance on the current economic situation as I understand it. (I've never taken an economics class or anything, so my understanding is probably pretty shallow; please correct me if I get anything wrong.)
Normally, when the economy starts to decline, the best way to get more money into the system is for the Federal Reserve to lower interest rates (this is called fiscal stimulus). The problem right now is that interest rates have stayed low ever since the Fed lowered them to help the economy after the dot-com bubble burst in 2000—in fact that was one of the main things driving the real estate bubble, i.e. cheap mortgages. After that bubble burst, the Fed lowered interest rates down to essentially zero, but that turns out not to be enough. Since interest rates can't go below zero, the Fed can't really do any more to help that way (this is called a liquidity trap). So the next best way to get money into the system is for the government to spend more money, i.e. to run a bigger budget deficit (this is called economic stimulus).
In the long run, deficit spending is bad, because it drives up the debt, which causes inflation. And it seems to go against common sense: if times are tough, shouldn't the government tighten its belt just like its citizens are having to? But, as Krugman says, "When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly." When consumers and businesses start saving instead of spending, the government is the only one left who can spend, so it has to take up the slack by spending more. Moreover, spending too much is safer than spending too little: if it spends too much and the economy grows too quickly, the Fed can raise interest rates to combat inflation. But if it spends too little, or too slowly, and a full recovery doesn't appear on the horizon, consumers will continue to save rather than spend, businesses will continue to cut jobs, and the economy will go further down the spiral.
So, how much spending is needed? The $800 billion stimulus package that Obama proposed sure sounded pretty huge-mongous. But all the numbers are big when you're talking about the national economy; the Congressional Budget Office estimates that GDP will drop $2.9 trillion over the next three years. So the stimulus was already too small, and centrists in Congress whittled it down further. As Krugman asks, "shouldn’t Obama have made a much bigger plan, say $1.3 trillion, his opening gambit?" The centrists wouldn't have asked for a corresponding $500 billion more in cuts; they could haggle it down to $1.2 trillion and look like they were being prudent and reining in excess spending, while still ending up with a big enough number to stay in scale with the problem.
Note that there are two ways for the government to "spend" money: actual spending, and tax cuts. Of course, this is the fundamental split between the parties; Democrats want the government to provide services for the public good, like roads and bridges, scientific research, and universal health care, while Republicans want to give money directly to the people. Putting aside the philosophical debates about socialism vs. libertarianism, there are two economic arguments in favor of spending over tax cuts:
Okay, I'm running out of steam on this project, and getting tired of searching for specific links for each point. But I'll briefly go over some other topics and what I think is Krugman's take.
Normally, when the economy starts to decline, the best way to get more money into the system is for the Federal Reserve to lower interest rates (this is called fiscal stimulus). The problem right now is that interest rates have stayed low ever since the Fed lowered them to help the economy after the dot-com bubble burst in 2000—in fact that was one of the main things driving the real estate bubble, i.e. cheap mortgages. After that bubble burst, the Fed lowered interest rates down to essentially zero, but that turns out not to be enough. Since interest rates can't go below zero, the Fed can't really do any more to help that way (this is called a liquidity trap). So the next best way to get money into the system is for the government to spend more money, i.e. to run a bigger budget deficit (this is called economic stimulus).
In the long run, deficit spending is bad, because it drives up the debt, which causes inflation. And it seems to go against common sense: if times are tough, shouldn't the government tighten its belt just like its citizens are having to? But, as Krugman says, "When depression economics prevails, the usual rules of economic policy no longer apply: virtue becomes vice, caution is risky and prudence is folly." When consumers and businesses start saving instead of spending, the government is the only one left who can spend, so it has to take up the slack by spending more. Moreover, spending too much is safer than spending too little: if it spends too much and the economy grows too quickly, the Fed can raise interest rates to combat inflation. But if it spends too little, or too slowly, and a full recovery doesn't appear on the horizon, consumers will continue to save rather than spend, businesses will continue to cut jobs, and the economy will go further down the spiral.
So, how much spending is needed? The $800 billion stimulus package that Obama proposed sure sounded pretty huge-mongous. But all the numbers are big when you're talking about the national economy; the Congressional Budget Office estimates that GDP will drop $2.9 trillion over the next three years. So the stimulus was already too small, and centrists in Congress whittled it down further. As Krugman asks, "shouldn’t Obama have made a much bigger plan, say $1.3 trillion, his opening gambit?" The centrists wouldn't have asked for a corresponding $500 billion more in cuts; they could haggle it down to $1.2 trillion and look like they were being prudent and reining in excess spending, while still ending up with a big enough number to stay in scale with the problem.
Note that there are two ways for the government to "spend" money: actual spending, and tax cuts. Of course, this is the fundamental split between the parties; Democrats want the government to provide services for the public good, like roads and bridges, scientific research, and universal health care, while Republicans want to give money directly to the people. Putting aside the philosophical debates about socialism vs. libertarianism, there are two economic arguments in favor of spending over tax cuts:
First, if the government spends money, that money is spent, helping support demand, whereas tax cuts may be largely saved. So public investment offers more bang for the buck. Second, public investment leaves something of value behind when the stimulus is over.Estimates say that each dollar of public spending results in a $1.50 increase in GDP, whereas the results of tax cuts are closer to 1-to-1. This is not an either-or question; there may not be enough "shovel-ready" projects for spending to have an immediate effect, so the stimulus should be a combination of spending and tax cuts both. But 100% tax cuts (like the DeMint amendment, which would have replaced Obama's $800 billion with $3.1 trillion—so much for the deficit hawks) would be much less efficient.
Okay, I'm running out of steam on this project, and getting tired of searching for specific links for each point. But I'll briefly go over some other topics and what I think is Krugman's take.
- Bank bailouts: necessary in order to relieve the credit crunch. (Letting Lehman Brothers fail didn't "teach Wall Street a lesson", it just made everyone panic and exacerbated the problems.) But we should get something in exchange for the bailout money, i.e. temporary ownership of the banks. The Obama administration is afraid of anything that could be called nationalization, but it's what the FDIC does all the time with smaller banks, and they should, and do, get re-privatized within five years.
- Fannie and Freddie: there was corruption there, but they were accounting scandals, and while they were dealing with that they actually reduced their involvement in the bad lending practices that were going on throughout the mortgage industry. So you can't blame the subprime mess on them (or Barney Frank/Chris Dodd).
- Housing prices: still inflated, because it takes much longer for owners to give up and lower their prices than it did for them to raise prices during the bubble. They still have another 10-20% to fall back to historical norms, and buying up foreclosures or other plans to put a floor on housing prices will just delay the natural market operation.
- Social Security is not in trouble; Medicare is the problem, and it's due to spikes in health care costs.
- Government health care coverage can be more efficient (i.e. cost less per citizen) than free-market privatized health care, but it only works if it's universal, i.e. everyone is mandated to have it. I think this was the main reason Krugman preferred Hillary to Obama, because Obama was using Republican talking points to attack mandates. This is probably worth another whole post when I get around to digging up the appropriate links.