Saturday, October 18, 2008

Professor Krugman is right: "Now is not the time to worry about the deficit"

In this case, Professor Krugman is right for the wrong reasons. First of all, the markets are thirsty for Treasury Bills (recall that the government runs a deficit by selling Treasury Bills, Notes, or Bonds) -- if you doubt me, just look at how low are their yields and how high are their prices. If the Treasury has a product that the market likes, than it should supply it until those prices and yields indicate that the markets have had enough. [This is Milton Friedman's Optimum Quantity of Money, applied to interest-bearing government liabilities. See also an AER paper by Professor Woodford called "Public Debt as Private Liquidity"]. I don't know whether liquidity will stimulate the economy, but even if it didn't, it's still efficient to provide liquidity when its cost of production is less than the market's valuation of it.

Second, it's time to cut taxes. Actually, it's always time to cut taxes! Cutting spending is politically more difficult. So you cut taxes first and let the growing interest payments on the public debt be your partner in the crusade against public spending [Reagan ran this program well].

Professor Krugman's argument (New Keynesian, and by no means novel) for running a deficit is to stimulate the economy with higher spending and/or lower taxes. This argument is either wrong, or absurd, or both. In the interests of brevity, I will deal with the absurd side of it and discuss the rest later. The New Keynesian argument why deficits would stimulate the economy is that the economy is perpetually depressed by excessive monopoly, especially during recessions (the so-called counter-cyclical markups), and that fiscal (or monetary) stimulus is a roundabout way of forcing monopolists to reduce their prices. But that's the Justice Department's (aka, DOJ) job, and the Justice Department has tools that are much better suited for dealing with monopolists' anti-competitive practices. I repeat my Query to New Keynesians -- What do You Have Against the DOJ?.


Donald Pretari said...

Well, I guess, one objection would be, which you seem to have anticipated,that the DOJ is either not doing the job or not doing it well. As well, litigation might simply take too long to alter our situation in a timely fashion. I brought this up with start up capital for new banks.

Since we both seem to have agreed that we're being left with too few banks, it does seem that certain industries have currently become more concentrated. I don't know how widespread this concentration might be, but it might be a factor.

However, I don't like indirect methods as a rule. If it were just a matter of lowering prices, why wouldn't price controls work? As well, if there are monopolists at work, surely it would be better to target money towards getting competition in place.

This basis for a stimulus does seem to be a bit thin, at least to an idiot like me.

Don the libertarian Democrat

Steve Roth said...

The US taxes 28% of GDP (federal, state, local combined).

European countries tax between 30 and 50% (40% average). Been that way for decades.

Over those same decades, economic growth in the two areas has been the same.


1. In prosperous, developed countries within these taxation ranges, tax burden does not have a significant impact on growth.

2. Tax burden does have a significant impact on growth, with one of two inevitable conclusions:

A. If Europe had taxed less, they would have been kicking our ass for several decades.

B. If we had taxed more, we would have been kicking theirs.

Note that the results from dozens of econometric studies resoundingly support conclusion #1.

It's time to put this myth to bed.

Amicus said...
This comment has been removed by the author.
Amicus said...

I agree with PK that some type of direct relief to the housing markets are in order. He did say that, right, or are we after a "general stimulus"?

Infrastructure is a really, really good and timely idea.

Otherwise, I don't like the selling points.

It is always time to worry about the deficit. Always.

It is not always time to cut taxes.

Sometimes, it is best for there to be ... you know, what big, fat, lazy Republics cannot seem do until they "fall": set priorities and sacrifice.

Even FDR ... paid for the war, as did Truman.

In the 1920s, no tax cuts until they were paid for (not the other way around, as it was during the Reagan Devolution, in the 1980s).

Unknown said...

This is more in reference to your previous posts rather than this post specificly. But, Anna Schwartz seems to generally agree with your view of the current crisis. You may have seen this article in the WSJ already but I thought I would post this just in case you haven't.

happyjuggler0 said...

This argument is either wrong, or absurd, or both.

Based on your blog thus far, you have a wonderful pedagogical skill (a good asset in a professor!), and as such I'd love to hear your explanation of the former, even if it lacks in "brevity". Perhaps on a slow news day?

Thanks in advance.