Like a spoiled brat, Krugman stomps his feet and cries that it´s fiscal stimulus or nothing. Surely, he pays lip service to monetary policy but since we are stuck in his beloved liquidity trap-ISLM world, there´s almost nothing the Fed can do!
That surely has helped polarize the ‘debate’, so I feel not all is lost when I get to read something like this piece from Clive Crook:
In a column last week I criticized Paul Krugman’s apparent belief that people who disagree with him — let’s say about half the country — are knaves, fools or sociopaths. I said his disdain was not just absurd but also politically counterproductive. Krugman responded to my “screed,” as he called it. His main point was that the disagreement over fiscal stimulus isn’t really a political disagreement at all. On one side, you have people who accept some simple, uncontested facts; and on the other, you have people too knavish, stupid or sociopathic to understand when those facts are patiently explained to them.
In particular, he argued, the debate over the fiscal stimulus has nothing to do with the proper scale and scope of government — an issue on which he seems to concede (somewhat to my surprise) that reasonable people may disagree. Whatever you think about the proper scale and scope of government, he says, you should be willing to go for a big fiscal stimulus when interest rates are at zero and demand is lacking. This has nothing to do with values or ideologies.
In any event, the main point is that the composition of the stimulus dominated the discussion throughout, as Krugman insisted it should. That put divisive value judgments about the size and scope of government at the center of the quarrel. Not everything is political, as Krugman rightly says. But the stimulus debate was as political as it gets, and, in no small part, that was thanks to Krugman.
All this comes out clearly in Krugman´s May 6 column for the NYT, but I want to be specific in my comment, so I´ll concentrate on one of his favorite arguments, and show it´s misleadingly wrong. Krugman writes:
F.D.R. cut back sharply in 1937, plunging America into recession; the Recovery Act had its peak effect in 2010, and has since faded away, a fade that has been a major reason for a slow recovery.
Wow! In 1937 real government purchases recoiled 4.2% and the economy tanked. In 2012 real government purchases were 4.8% below the 2010 level and the recovery is slow!
Surely something is going on that´s making comparable ‘fiscal austerity’ so much less damning in 2012 than in 1937.
And that ‘something’ is monetary policy.
There are several studies that indicate that it was monetary policy that bore the major responsibility for the severity of the ‘recession within the depression’. My favorite is Doug Irwin´s Gold Sterilization and the Recession of 1937-38. The abstract reads:
The Recession of 1937-38 is often cited as illustrating the dangers of withdrawing fiscal and monetary stimulus too early in a weak recovery. Yet our understanding of this severe downturn is incomplete: existing studies find that changes in fiscal policy were small in comparison to the magnitude of the downturn and that higher reserve requirements were not binding on banks.
This paper focuses on a neglected change in monetary policy, the sterilization of gold inflows during 1937, and finds that it exerted a powerful contractionary force during this period. The transmission of this monetary shock to the real economy appears to have worked through lower asset (equity) prices and higher interest rates.
This is how the 1937 – 38 and 2010 – 12 versions of the ‘movie’ evolved.
While in 1937-38 nominal spending (NGDP) tanked (all the constraining factors are listed), in the 2010-12 version nominal spending keeps chugging along at a reasonably stable rate of 3.8%.
The next scene indicates that when the ‘monetary actor walked out of the set’ in 1937, spending shot down. And when it came back on set spending ‘shot up’ again!
The last frame compares an important scene from the two versions of the movie. In both, the ‘fiscal actor’ is refusing to ‘act’. In the earlier version the monetary ‘actor’ does not satisfy the demands of his ‘leading lady’ (money demand is rising/velocity falling) while in the new version he partly satisfies her ‘wishes’ so that spending keeps rising, albeit less than would be desirable. If only ‘he’ could give ‘her’ more ‘satisfaction’ the ending would be much ‘brighter’.
So I believe that Krugman, the NYT ‘film critic’ is desperately trying to bring back a ‘failed actor’ from retirement’. He would be much more helpful if he focused on ‘coaching’ the ‘leading man’ into an ‘Oscar performance’.
PS. This is how a monetary policy ‘guitar’ should be played: Beautifully and widely applauded:
Update: Suggested reading for Krugman:
We document that current views about the causes of the Depression were anticipated in the 1920s by Ralph Hawtrey and Gustav Cassel who independently warned that restoring the gold standard risked causing a disastrous deflation unless the resulting increase in the international monetary demand for gold could be limited. Although their early warnings of potential disaster were validated, and their policy advice after the Depression started was consistently correct, their contributions were later ignored or forgotten. This paper explores the possible reasons for the remarkable disregard by later economists of the Hawtrey-Cassel monetary explanation of the Great Depression.