Why Paul Krugman Is Wrong

Professor Krugman keeps fighting a straw-man argument. The real issue isn't a choice between stimulus and austerity. After all, we've had nearly five years of quite remarkable monetary and fiscal policy stimulus.
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Nobel laureate and Princeton economics professor Paul Krugman has, for many months, been writing and rewriting basically the same article in The New York Times. The essence of Professor Krugman's argument is that austerity policies are misguided and are strangling the slow US economic recovery; what is needed is more Keynesian-style fiscal policy -- more government deficit spending on teachers, roads, bridges, and energy projects. With consumer demand sluggish and the housing market still not back to normal, Professor Krugman contends that more government stimulus is urgently required to sustain the recovery and spark renewed economic growth.

Professor Krugman keeps fighting a straw-man argument. The real issue isn't a choice between stimulus and austerity. After all, we've had nearly five years of quite remarkable monetary and fiscal policy stimulus: George W. Bush's Troubled Asset Relief Program, Obama's stimulus program, cash-for-clunkers, subsidies for first-time home buyers, plus multiple rounds of "quantitative easing" by the Federal Reserve. Moreover, for nearly five years, interest rates have hovered close to zero, and in real terms (after our modest inflation rate is considered) interest rates have effectively been negative.

So why isn't the U.S. economy booming, with growth well above three or even four percent annually? Consumers should be flocking to the stores buying cars and refurbishing their homes. Companies should be investing their $2 trillion cash hoard and assuming even more debt. Professor Krugman argues that the government should add more debt now, especially given low interest rates, and worry about the repayment once the economy starts growing again. Shouldn't that "max out your credit cards" argument also follow for companies and consumers?

What is now "maxed out" is both monetary and fiscal policy. With interest rates negative, there is nothing more that monetary policy can do to stimulate the economy. And after trillions of dollars of federal deficit pump-priming, plus an expanded Federal Reserve balance sheet that reflects trillions more, to contend that we now need additional deficit spending defies credulity. Been there, done that.

The problems holding back U.S. economic growth have little to do with monetary or fiscal policy: they are structural in nature and relate directly to the incentives, or disincentives, faced by established companies, entrepreneurs, and investors. French President Francois Hollande recently stated that France was "blocked" and needed to change; the same is true in the United States, where the blockages may be found in our cumbersome tax and regulatory policies, a campaign finance system that encourages and rewards rent-seeking rather than risk-taking, and capital markets that still behave like casinos rather than efficient allocators of investment capital.

As former Office of Management and Budget Director and Blackstone Group partner David Stockman explains in his superb new book, "The Great Deformation," today's hedge fund industry far too often relies on inside information; private equity firms keep basically doing deals with each other. Efforts to grow the economy through innovation, entrepreneurial investments, and risk-taking are less common than before the Great Recession. In Stockman's words: " The promise of huge synergies from acquisitions was a particularly potent catalyst for periodic stock ramps because Wall Street is replete with rumors and inside information about M & A deals."

Countries and their economies can become blocked for many reasons. I lived in England between 1973 and 1975. A miners' strike toppled the Conservative Heath government in February 1974, and the subsequent Wilson and Callaghan Labour governments were characterized by high inflation, high unemployment, labor market turmoil - endless strikes, work stoppages, plus occasional riots -- and the overall decline of civil society. When I left in 1975, I was convinced that England was beyond repair and that the country would only get worse.

And the United States to which I returned wasn't much better. Inflation was rising rapidly, along with unemployment, even though Vietnam War expenditures were declining. The following five years were seen as a period of economic and political "malaise".

The dynamic of decline changed dramatically in both countries as a result of the new leadership of Margaret Thatcher, elected in 1979, and Ronald Reagan, elected in 1980. Both leaders were unflappable optimists who rejected defeatism. Neither leader believed that their countries needed more government spending or more government intervention in the marketplace to turn around the economy. Reagan proved to be far more tolerant of big deficits than Thatcher, but both were committed to unblocking their respective economies. While their tactics were, of course, different given the contexts of each nation's experiences, Reagan and Thatcher changed the underlying structural incentives that enabled free market capitalism to flourish.

I am not arguing for a replay of the Thatcher-Reagan era, but I am suggesting that more attention to our economy's structural blockages (first and foremost the tax code plus our embarrassing campaign finance system) and incentives to encourage economic growth are what is needed.

As a nation, we have become addicted to debt, and our predilection to amass more and more debt cannot exactly be deemed "austerity." The "max out" argument is well underway when it comes to our young people. We have created a student-loan debacle in which mostly young Americans now owe more than $1 trillion in student-loan debt. Is it any wonder that so many of these individuals are living at home with their parents and find themselves unable to purchase much beyond bare essentials?

Can't we move beyond the sterile "stimulus versus austerity" debate into the more important - and more difficult - area of rethinking the structural impediments to economic growth? Perhaps we need to move to a consumption tax that rewards saving rather than consumption? We need to revisit the regulatory universe that stifles corporate innovation and entrepreneurial risk-taking. We need major campaign finance reform. And we need a complete overhaul when it comes to how our society and our economy handle debt.

Debts will have to be repaid (or written down, or excused, or defaulted upon), and unsustainable Federal Reserve balance sheets will have to be unwound. After all, interest rates will not always be negative. We should be thinking right now about how to do this and what new structural reforms we need to unblock our economy. Only then can we begin to reflect upon how monetary and fiscal policy might support a new era of economic growth, prosperity, and low unemployment that is not sustained by a mountain of debt.
Charles Kolb is president of the New York-based French-American Foundation-United States. From 1997 until 2012, he was president of the Committee for Economic Development, and he served as Deputy Assistant to the President for Domestic Policy in the George H.W. Bush White House (1990-1992). The views in this article are solely the author's.

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