The K-K ‘principle’ should read: It´s all proportional to the depth of the hole dug by the NGDP drop

Krugman defends the Keynesianism-Krugmanism with regards to some popular views on Latvian ‘success’:

OK, the recent Reinhart-Rogoff protest against “gross misinterpretations of the facts” on financial crises doesn’t actually say anything about Latvia. But the points R-R make in taking on the US crisis denialists apply with equal force to the weird phenomenon of Baltic triumphalism.

As R-R say, rapid growth over a short period following a deep slump does not constitute a success story; by that measure, America was a tower of prosperity in the depths of the Great Depression. It’s much more informative to focus on levels, both of output and of unemployment, and compare them with the pre-crisis peak.

So, people keep telling me that Latvia is an economic miracle that refutes Keynesianism and Krugmanism. How’s it doing on the level thing? (All data from Eurostat).

And shows this chart:

The equivalent US chart follows (on the same scale for ease of comparison):

Then there´s the unemployment picture in both countries

And finally, the “digger of misery”, the nominal spending level.

One would think that compared to Latvia, the US is a success story. But that would be misleading. In fact the US is proportionally doing just as bad as Latvia. The US was lucky (or maybe the Fed felt less constrained than Latvia´s CB) to see its spending fall much less than Latvia´s.

10 thoughts on “The K-K ‘principle’ should read: It´s all proportional to the depth of the hole dug by the NGDP drop

  1. @Marcus,

    Another explanation beside the strictly monetary policy one is that the U.S. stimulus worked, albeit wasn’t big enough to push us into a full-fledged medium-run recovery. I suppose it would be difficult to disentangle the various forces to say for sure.

  2. I was wondering whether you think the fed has historically been too hawkish about inflation. I mean if the fed had an implicit inflation target of 3%, instead of 2%, it seems to me that policy would have been accommodative enough maybe before hitting the zlb to bring a brisk recovery of about -1% unemployment per year…

  3. Actually it´s all proportional to the depth of the hole dug by the NGDP drop *relative to trend*.

    NGDP in Latvia grew at an average annual rate of 15.2% in the ten years through 2008Q2. In the US it only grew at an average annual rate of 5.2%. Thus as of the second quarter Latvia is 48% below trend whereas the US is only 12% below trend.

    So things are indeed as bad in Lavia as the RGDP and unemployment figures suggest.

  4. I don’t understand Krugman very well, but it seems like his point is that the case of Latvia doesn’t prove anything. I agree with that – most of the globe has inflation/bubble obsessed central banks and so monetary policy is suboptimal nearly everywhere. I think that if someone is looking for case that disproves fiscal stimulus works in all cases and can be a substitute for appropriate monetary policy, they should be pointing to Japan where the government has borrowed and spent hand over fist for decades. At first blush, one can say that it would have been much worse without Japanese fiscal stimulus, which is probably true in some sense, but I think we need to look at the point that it is supposed to become unnecessary at some point down the road. And by that standard, it has been an abject failure. Why many conservatives are stuck on bubble/inflation fear mongering is a real head-scratcher, as Japan is the poster child for nearly every point they have been trying to make about big government for the last 40 years.

  5. Some epochs are formative for people. Poeple who lived through the Great Depression never got over it. Or WWII.

    The Great Inflation left indelible mark on many economists.

    It is worse when these great epochs feed extant bias or prejudices. So the lesson from WWII is that we should be armed to the teeth forever, or from the Great Depression is that we need to regulate everything always and have huge safety nets.

    The Great Inflation left behind a legacy of abject inflation fears.

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