Even Paul sows confusion about the power of fiscal stimulus

Paul Krugman in 1998:

It seems to be part of the folk wisdom in macroeconomics that this is in fact how the Great Depression came to an end: the massive one time fiscal jolt from the war pushed the economy into a more favorable equilibrium. However, Christina Romer contends that most of the out- put gap created during 1929-33 had been eliminated before there was any significant fiscal stimulus. She argues that the main explanation of that expansion was a sharp decline in real interest rates, which she attributes to monetary policy (although most of the decline in her estimate of the real interest rate is actually due to changes in the inflation rate rather than the nominal interest rate). Indeed, Romer estimates that for most of the recovery period ex ante real rates were sharply negative, ranging between -5 and – 10 percent.

My point is that the end of the Depression, which is the usual, indeed perhaps the sole, motivating example for the view that a one-time fiscal stimulus can produce sustained recovery, does not actually appear to fit the story line too well. Much, though by no means all, of the recovery from that particular liquidity trap seems to have depended on inflation expectations that made real interest rates substantially negative.

But in 2011 he embraces the “folk wisdom”:

As regular readers know, I’ve pointed out that World War II ended the Great Depression. Then critics say, how could war, a destructive activity, do anything good? I answer that when the economy is in a liquidity trap, there are a lot of perverse consequences. And then the critics declare that I’m a warmonger.

For a countervaling view see here:

In his 2008 book, The Return of Depression Economics and the Crisis of 2008, Paul Krugman writes: “The Great Depression in the United States was brought to an end by a massive deficit-financed public works program, known as World War II.”

Update: Another Paul (Samuelson), who believed the war had ended the GD, (naturally) predicted in 1943:

“The final conclusion to be drawn from our experience at the end of the last war is inescapable—were the war to end suddenly within the next 6 months, were we again planning to wind up our war effort in the greatest haste, to demobilize our armed forces, to liquidate price controls, to shift from astronomical deficits to even the large deficits of the thirties—then there would be ushered in the greatest period of unemployment and industrial dislocation which any economy has ever faced.”

HT Becky Hargrove

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7 thoughts on “Even Paul sows confusion about the power of fiscal stimulus

  1. That’s a great find. Why would PK change his mind? Campaigning, pro-big government prejudice overcoming inconvenient facts? Even facts he used to know.

    • And you can see he has this confusion about what constitutes monetary policy.:
      “She argues that the main explanation of that expansion was a sharp decline in real interest rates, which she attributes to monetary policy (although most of the decline in her estimate of the real interest rate is actually due to changes in the inflation rate rather than the nominal interest rate)”.

      Monetary policy would have been a reduction in interest rates. But I ask, where the hell does the increase in inflation expectations come from?

      • He does understand, surely, as elsewhere in the piece he says:
        “The traditional view that monetary pol- icy is ineffective in a liquidity trap, and that fiscal expansion is the only way out, must therefore be qualified: monetary policy will in fact be effective if the central bank can credibly promise to be irresponsible, to seek a higher future price level.”

        Somewhat typically the footnote reference to Romer tries to take back the support he has just given her work by arguing the output gap was still very large in 1940.

    • I suppose understanding PK’s motivation is beyond our ken. The style reminds me of prize-winning school essays where you won if you stylishly articulated all sides of an argument without coming to any firm conclusion.

  2. The macro world has blown a fuse lately.

    Williamson, Krugman, predictions of hyperinflation, then bubbles, people rhapsodizing about deflation, people predicting QE causes deflation, hyperinflation, jobless recoveries…

    I hate to sound cocky, but has any group, with the exception of the MM crowd, been even close to accurate? Believe me, if I thought some other group was doing a batter job in macroeconomics, then I would change…but who? Where?

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