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Thu Jun 28, 2012, 05:26 AM

Paul Krugman in NYT: A Manifesto For Economic Sense

http://krugman.blogs.nytimes.com/2012/06/28/a-manifesto-for-economic-sense/

June 28, 2012, 4:46 AM

A Manifesto for Economic Sense

As regular readers know, Iíve been arguing for a long time that policy makers have misunderstood the nature of our economic crisis, mistaking symptoms for causes, and responding in ways that make the situation worse. Richard Layard and I now have a manifesto laying out the essence of this case, and are asking other economists to sign on.


http://www.manifestoforeconomicsense.org/

A Manifesto for Economic Sense

More than four years after the financial crisis began, the worldís major advanced economies remain deeply depressed, in a scene all too reminiscent of the 1930s. And the reason is simple: we are relying on the same ideas that governed policy in the 1930s. These ideas, long since disproved, involve profound errors both about the causes of the crisis, its nature, and the appropriate response.

These errors have taken deep root in public consciousness and provide the public support for the excessive austerity of current fiscal policies in many countries. So the time is ripe for a Manifesto in which mainstream economists offer the public a more evidence-based analysis of our problems.

The causes. Many policy makers insist that the crisis was Ocaused by irresponsible public borrowing. With very few exceptions - other than Greece - this is false. Instead, the conditions for crisis were created by excessive private sector borrowing and lending, including by over-leveraged banks. The collapse of this bubble led to massive falls in output and thus in tax revenue. So the large government deficits we see today are a consequence of the crisis, not its cause.

The nature of the crisis. When real estate bubbles on both sides of the Atlantic burst, many parts of the private sector slashed spending in an attempt to pay down past debts. This was a rational response on the part of individuals, but - just like the similar response of debtors in the 1930s - it has proved collectively self-defeating, because one personís spending is another personís income. The result of the spending collapse has been an economic depression that has worsened the public debt.

The appropriate response. At a time when the private sector is engaged in a collective effort to spend less, public policy should act as a stabilizing force, attempting to sustain spending. At the very least we should not be making things worse by big cuts in government spending or big increases in tax rates on ordinary people. Unfortunately, thatís exactly what many governments are now doing.

The big mistake. After responding well in the first, acute phase of the economic crisis, conventional policy wisdom took a wrong turn - focusing on government deficits, which are mainly the result of a crisis-induced plunge in revenue, and arguing that the public sector should attempt to reduce its debts in tandem with the private sector. As a result, instead of playing a stabilizing role, fiscal policy has ended up reinforcing the dampening effects of private-sector spending cuts.

In the face of a less severe shock, monetary policy could take up the slack. But with interest rates close to zero, monetary policy - while it should do all it can - cannot do the whole job. There must of course be a medium-term plan for reducing the government deficit. But if this is too front-loaded it can easily be self-defeating by aborting the recovery. A key priority now is to reduce unemployment, before it becomes endemic, making recovery and future deficit reduction even more difficult.

How do those who support present policies answer the argument we have just made? They use two quite different arguments in support of their case.

The confidence argument. Their first argument is that government deficits will raise interest rates and thus prevent recovery. By contrast, they argue, austerity will increase confidence and thus encourage recovery.

But there is no evidence at all in favour of this argument. First, despite exceptionally high deficits, interest rates today are unprecedentedly low in all major countries where there is a normally functioning central bank. This is true even in Japan where the government debt now exceeds 200% of annual GDP; and past downgrades by the rating agencies here have had no effect on Japanese interest rates. Interest rates are only high in some Euro countries, because the ECB is not allowed to act as lender of last resort to the government. Elsewhere the central bank can always, if needed, fund the deficit, leaving the bond market unaffected.

Moreover past experience includes no relevant case where budget cuts have actually generated increased economic activity. The IMF has studied 173 cases of budget cuts in individual countries and found that the consistent result is economic contraction. In the handful of cases in which fiscal consolidation was followed by growth, the main channels were a currency depreciation against a strong world market, not a current possibility. The lesson of the IMFís study is clear - budget cuts retard recovery. And that is what is happening now - the countries with the biggest budget cuts have experienced the biggest falls in output.

For the truth is, as we can now see, that budget cuts do not inspire business confidence. Companies will only invest when they can foresee enough customers with enough income to spend. Austerity discourages investment.

So there is massive evidence against the confidence argument; all the alleged evidence in favor of the doctrine has evaporated on closer examination.

The structural argument. A second argument against expanding demand is that output is in fact constrained on the supply side - by structural imbalances. If this theory were right, however, at least some parts of our economies ought to be at full stretch, and so should some occupations. But in most countries that is just not the case. Every major sector of our economies is struggling, and every occupation has higher unemployment than usual. So the problem must be a general lack of spending and demand.

In the 1930s the same structural argument was used against proactive spending policies in the U.S. But as spending rose between 1940 and 1942, output rose by 20%. So the problem in the 1930s, as now, was a shortage of demand not of supply.

As a result of their mistaken ideas, many Western policy-makers are inflicting massive suffering on their peoples. But the ideas they espouse about how to handle recessions were rejected by nearly all economists after the disasters of the 1930s, and for the following forty years or so the West enjoyed an unparalleled period of economic stability and low unemployment. It is tragic that in recent years the old ideas have again taken root. But we can no longer accept a situation where mistaken fears of higher interest rates weigh more highly with policy-makers than the horrors of mass unemployment.

Better policies will differ between countries and need detailed debate. But they must be based on a correct analysis of the problem. We therefore urge all economists and others who agree with the broad thrust of this Manifesto to register their agreement at www.manifestoforeconomicsense.org, and to publically argue the case for a sounder approach. The whole world suffers when men and women are silent about what they know is wrong.

Signed by:
Paul Krugman, Princeton University
Richard Layard, LSE Centre for Economic Performance

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Reply Paul Krugman in NYT: A Manifesto For Economic Sense (Original post)
Hissyspit Jun 2012 OP
Live and Learn Jun 2012 #1
xchrom Jun 2012 #2
Sherman A1 Jun 2012 #3
tclambert Jun 2012 #4
GetRidOfThem Jun 2012 #5
Dustlawyer Jun 2012 #6
hay rick Jun 2012 #7
phantom power Jun 2012 #8
hfojvt Jun 2012 #9
Electric Monk Jun 2012 #10

Response to Hissyspit (Original post)

Thu Jun 28, 2012, 05:42 AM

1. Krugman is a voice of reason drowned out by a cacophony of propaganda. nt

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 06:24 AM

2. Du rec. Nt

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 06:45 AM

3. K&R

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 06:49 AM

4. Please support his effort.

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 08:18 AM

5. Interesting Factoid: I read this today in the Op/Ed of the Financial Times.

The Financial Times is the original publisher of this manifesto, not the NYT. The FT is actually an interesting paper with liberal overtones (which is why Murdoch wanted to destroy it...)

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 09:23 AM

6. I like this attempt to keep his voice from "being drowned!".

Obama can use this in the election to appeal to Repugs so they can make $. What can Romney et al. do to counter it? The only thing he can, buy his own economists!

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 10:39 AM

7. Voices in the wilderness.

K&R.

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 11:17 AM

8. recommend

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 11:19 AM

9. is it really about "mistaken" ideas?

It seems to me that policy makers are not making honest "mistakes" but are instead listening to the demands of their owners - those in the top 20%. Maybe some in the top 20% are taken in by mistaken ideas, but many are simply making cold calculations - what is good for my immediate bottom line? The fact that what is good for them in the short run is "inflicting massive suffering on their peoples." That's not something they really give a crap about. In fact, it is quite likely that they can profit from that suffering. They can offer lower wages and they can buy cheap property. For them that massive suffering is a win-win.

The mistaken ideas are held by many voters in the bottom 80% who have been duped by all the propaganda from the top. Sadly, most of them are never gonna see this manifesto, unless you can make it into a video that goes viral, or buy a full page ad in USA today (but how many people read that paper?). Go on the Tonight Show or something.

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Response to Hissyspit (Original post)

Thu Jun 28, 2012, 03:31 PM

10. K&R

&U&G&M&A&N

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