Here’s Paul Krugman describing the effects of recent fiscal policy in the US:
And to do this when the private sector is still deleveraging and interest rates are at the zero lower bound is just awesomely destructive.
It is true that Krugman suggested the fiscal austerity imposed in the US in 2013 would be awesomely destructive. And it is true that he said 2013 would be a test of market monetarism, and in particular monetary offset. But it’s also true that job growth in 2013 is running ahead of the pace of recent years, despite a big rise in payroll taxes, as well as income tax increases and the budget sequester. And a huge fall in the budget deficit.
It would be more accurate to say that fiscal austerity is awesomely destructive when the austerity involves measures that increase the rate of inflation, and the central bank has a single mandate to keep inflation below 2%, and takes that mandate so seriously that it raised interest rate several times in 2011, and not awesomely destructive if the central bank is at least slightly rational. The US and eurozone did almost identical amounts of austerity. No surprise, it’s the ECB policy that is awesomely destructive:
David Henderson notes some other problems with the Krugman post.
Consider Brad’s five points:
1. Price stickiness causes business cycle fluctuations: You clearly need price stickiness to make sense of the data. However, there is now widespread acceptance of the point that making prices more flexible can actually worsen a slump, a favorite point of Tobin’s.
2. Monetary policy > fiscal policy: Not when you face the zero lower bound — and that’s no longer an abstract or remote consideration, it’s the world we’ve been living in for five years. And Tobin, who defended the relevance of fiscal policy, is vindicated.
3. Business cycles are fluctuations around a trend, not declines below some level of potential output: This view comes out of the natural rate hypothesis, and the notion of a vertical long-run Phillips curve. At this point, however, there is wide acceptance of the idea that for a variety of reasons, but especially downward nominal wage rigidity, the Phillips curve is not vertical at low inflation. Again, a very Tobinesque notion, as Daly and Hobijn explain.
4. Policy rules: Not so easy when once in a while you face Great Depression-sized shocks.
5. “Low multipliers associated with fiscal policy”: Ahem. Not when you’re in a liquidity trap.
I think Krugman is complete wrong about points 1, 2, 4, and 5 (not wrong that some Keynesians have shifted that way, but wrong in implying this new old Keynesianism is an improvement.) Is there any European country with more flexible wages than Germany? Point 3 is complicated. My hunch is that even at low inflation rates (say 1%) unemployment will generally get back to the same natural rates as at 5% inflation. But I do think recoveries take longer at 1% inflation, so the average rate of unemployment is higher at low rates. And there is some possibility that you never get back to the original natural rate at low inflation rates, if money illusion (irrational fear of nominal wage cuts) creates a higher natural rate of unemployment. So I think Krugman is at least partly right on that point. Of course this entire discussion should have been done in NGDP growth terms, but I stuck with Krugman’s terminology.