Insights & Advice


Is Krugman Right?

Economist Paul Krugman, Nobel Laureate and New York Times columnist has suggested a solution to this Great Recession. It is a controversial suggestion and one that flies in the face of today’s political wisdom. It just might work.

A common fallacy among Americans is that Franklin Delano Roosevelt’s economic policies extricated the United States from the Great Depression of the 1930s. Others, with more knowledge of those times, recognize that it was the onset of World War II and the U.S. preparation to wage that war, which truly pulled us out of that economic mire. But stripping that truth down to its bare essentials leaves us with one fact.

To pull this country out of the Great Depression, government spending had to be raised to 43.6% of GDP in 1943, 43.6% in 1944 and 41.9% in 1945. Only in 1946 did spending drop back to 24.8%. In his new book, “End This Depression Now,” Krugman argues that the answer to our present economic dilemma, which he terms “a second depression,” is to spend our way out of recession as we did during WWII.

As today’s leading proponent of legendary economist John Maynard Keynes, Paul Krugman believes his mentor had it right when he advised government that “the boom, not the slump, is the time for austerity.” He argues that Keynes’s definition of a depression, “a chronic condition of subnormal activity for a considerable period without any marked tendency towards recovery or toward collapse,” applies to our economic reality today. We are in what Keynes referred to as a liquidity trap in which an indebted private sector is so intent on rebuilding its savings that even interest rates of zero cannot tempt it to borrow and spend enough to get the economy working again at full capacity.

Sound familiar?

Of course Krugman’s ideas fly directly in the face of all the austerity rhetoric that is emanating from both political parties during the run-up to November’s presidential elections. Both parties seem to believe that the only way forward is to either raise taxes on some; (or cut taxes on others) and cut spending.  

In fact, raising taxes and cutting spending is exactly what Herbert Hoover did back in the early 1930s, just as the economy was struggling to recover from the crash of 1929. In my opinion, Hoover’s austerity policies, like those that many conservatives are advocating today, are what drove this country from a prolonged recession into its first Great Depression.

In essence, Krugman is suggesting we increase government spending back to the levels of WWII, if necessary. Today, government in total spends around 36% of GDP, if you include all goods, services, cash and transfer payments. That represents over one third of all spending in this country. Clearly Krugman’s answer to solving this country’s woes would make government bigger while creating the most powerful economic entity we’ve seen since the 1940s.

In the end, we may very well do just what Krugman suggests. I don’t believe the majority of Americans will consciously vote for austerity. Raising their own taxes and cutting spending that they need—especially on Medicare and Social Security–would not be in our individual interests, regardless of how well it may be for the future posterity of our children and children’s children.

The two biggest concerns American voters will have as they vote this year is staying employed or getting re-employed. Worries over the debt ceiling, the deficit and America’s future concern us theoretically but those issues do not impact our pocket book today. If Americans are faced with a program of prolonged austerity after the November elections, I am convinced that they will vote the responsible party out of office as soon as possible.

  Under that scenario, if borrowing, spending more and ultimately inflating our national debt away is easier (and safer) than austerity, then guess what most politicians will do?  If you doubt that, ask yourself who was the more popular President—Hoover or FDR? That’s my point.

A note to my readers in the Berkshires:

I have volunteered to teach a course this fall at Berkshire Community College at the Osher Lifelong Learning Institute (OLLI). The classes will be on Mondays from 2:45-4:15 PM throughout September and October. The course, entitled “America’s Future: Buy, Sell or Hold?” will teach students to think critically about such events as this year’s presidential elections, wealth and women, our education system and much more. For more information or to sign up for the course call the OLLI Office at 413-236-2190.

Posted in Macroeconomics, The Retired Advisor