Oversimplifying the Ignoramus Strategy

I enjoyed this post from Paul Krugman (despite its borderline ad hominem approach – which I think is more playful than insulting really).  He rather succinctly describes the environment of the last few years, why austerians have been wrong, and why the government’s budget deficit has been a benefit and not a cost to the US economy.  But I don’t know if the post is descript enough.  Here’s what he says specifically (with my comments in bold):

“1. The economy isn’t like an individual family that earns a certain amount and spends some other amount, with no relationship between the two. My spending is your income and your spending is my income. If we both slash spending, both of our incomes fall.”

Precisely.  This is Wynne Godley 101.  As the sector financial balances clearly show, one sector’s spending is another sector’s income.  See the following chart for instance:

“2. We are now in a situation in which many people have cut spending, either because they chose to or because their creditors forced them to, while relatively few people are willing to spend more. The result is depressed incomes and a depressed economy, with millions of willing workers unable to find jobs.”

Precisely, this is balance sheet recession theory 101.  When the debt bubble hit spenders turned into savers because they were concerned about the health of their balance sheets as asset values collapsed and incomes declined.  MRists are more specific though.  We understand there are times when supply side problems exist and when demand side problems exist (so, in an environment like today, we emphasize demand side problems).  

“3. Things aren’t always this way, but when they are, the government is not in competition with the private sector. Government purchases don’t use resources that would otherwise be producing private goods, they put unemployed resources to work. Government borrowing doesn’t crowd out private borrowing, it puts idle funds to work. As a result, now is a time when the government should be spending more, not less. If we ignore this insight and cut government spending instead, the economy will shrink and unemployment will rise. In fact, even private spending will shrink, because of falling incomes.”

I’d say MOSTLY right.  But there are definitely instances where the government could compete with the private sector for jobs and hurt overall output.  

“4. This view of our problems has made correct predictions over the past four years, while alternative views have gotten it all wrong. Budget deficits haven’t led to soaring interest rates (and the Fed’s “money-printing” hasn’t led to inflation); austerity policies have greatly deepened economic slumps almost everywhere they have been tried.”

Right.  Monetary Realism emphasizes understanding the structure of a monetary system from its institutional roots up.  In Europe where nations are currency users with a foreign central bank the nations have solvency constraints.  The USA is entirely different.  So there’s an element of “it depends” in PK’s comment which I think is very important.  

“5. Yes, the government must pay its bills in the long run. But spending cuts and/or tax increases should wait until the economy is no longer depressed, and the private sector is willing to spend enough to produce full employment.”

Not exactly.  The government doesn’t HAVE to pay off the national debt over the long-term.  Remember, the government’s debt is the non-government’s saving.  Ie, the government’s issued t-bond make up part of grandma and grandpa’s savings accounts in the same way that a corporation’s liabilities (like corporate bonds) are someone’s savings.  Dr. Krugman seems to have forgotten bullet point #1.   Anyhow, the more important point is not that the government has to “pay off” the debt, but that it must be cognizant of how this debt impacts the private sector and perhaps more importantly, how its spending impacts private output.  For instance, government spending could be entirely counterproductive if it resulted in paying 300 million Americans to sit on their couches all day (yes, extreme example, but you get the point).  

Anyhow, those are my big picture thoughts there.  What are yours?