Paul Krugman has been busy. He must have invested in a book of insults, for he has certainly managed to find quite a few, and has then thrown them at Oli Rehn, the European Commissioner for Economic and Monetary Affairs and the Euro. He has also had a go at – well not sure who he had in mind exactly, but he has come up with the word Osbornia. It’s that spending versus cutting thing, of course. But there something that Mr Rehn and a bloke called David Cameron, who is a kind of figure head in Osbornia, have in common. And that is that they say they would if they could but they can’t. The fiscal cupboard, they say is empty. Meanwhile, the IMF seems to be siding with Krugman.
If we lived in a world of perfect knowledge there would be no point in a government funded stimulus. In such a world tax payers would realise that extra government debt would mean higher taxes in the future, and they would thus save more in anticipation of these higher taxes. In fact, in this world of perfect knowledge any government stimulus would be met by an identical rise in savings in the private sector. You may have spotted the fatal flaw with that argument. We don’t live in a world of perfect knowledge. Despite this rather self-evident flaw, many economists still sign-up to that point of view. Paul Ryan in the US is amongst them – or at least he more or less goes with that idea.
And by the way, some go even further. They say that since we have perfect knowledge, during the build-up to the crisis of 2008, households and corporates recognised that Obama was going to win the US election. In anticipation of the extra government spending his victory would entail, continues the argument, they immediately saved more, thereby forcing the US into recession. In short, Obama caused the global economic crisis, even before he was in the White House. It just goes to show that if you are sufficiently biased and convinced about your own rhetoric, you can find evidence in just about anything to support your belief.
The IMF, however, does not think like that. Don’t get me wrong, for my money the IMF let down South East Asia badly in the late 1990s, and the errors it made had consequences that may have been factors in creating the crisis of 2008. I also think the IMF is way too Western centric, and is badly in need of a leader from outside Europe. But the IMF is a lot cuddlier these days; whereas it was once dominated by thinking that Attila the Hun may have found too right for his palette, today it is far more liberal.
Earlier this month an IMF report, written by Luc Eyraud and Anke Weber, pretty much sided with the Krugman camp. The report stated: “Studies suggest that fiscal multipliers are currently high in many advanced economies. One important implication is that fiscal tightening could raise the debt ratio in the short term, as fiscal gains are partly wiped out by the decline in output. Although this effect is not long lasting and debt eventually declines, it could be an issue if financial markets focus on the short-term behavior of the debt ratio, or if country authorities engage in repeated rounds of tightening in an effort to get the debt ratio to converge to the official target.” See: The Challenge of Debt Reduction during Fiscal Consolidation
The truth is that you can be a great believer in the need to cut government debt, but still hold to the view that at any given moment borrowing is required. There comes a point when cut backs, and attempts to reduce debt, can have such a catastrophic effect that they make total debt worse.
Nobel Laureate and ‘New York Times’ columnist Paul Krugman calls it “cockroach ideas.” It matters not how much we try to get rid of the little critters, cockroaches keep coming back. Krugman put it this way: “I think of cockroach ideas as misconceptions held because the people holding them are just unaware of basic facts.” And who was the victim of Krugman’s poetry? Why, it was none other than Oli Rehn. The Krugman argument is that Rehn and his austerity cohorts are making the crisis in the Eurozone ever more serious. He said the EU commissioner is responsible for a “Rehn of Terror.”
That is not very nice. Maybe Krugman should apologise for being so personal, scratch his scalp and say: “I am sorry Oli”.
You might have expected the EU commissioner to have responded by saying: “That’s another fine mess you are trying to get us into,” but instead he said: “What I don’t understand is where on earth the stimulus money could have come from.”
Of course David Cameron, Prime Minister of the land Krugman calls Osbornia, said something similar. He suggested that the money is just not there to fund a stimulus.
If you believe we live in a world of perfect knowledge, and an increase in government debt will be met by a rise in savings, both Cameron and Rehn are right. I am just not sure we do live in such a place.
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