KrugmanWatch – Against Stupidity…

If it wasn’t so sad it would be amusing how Paul Krugman has everything precisely backwards:

The most valuable lesson I learned from the year I spent in Washington (1982-1983, on the staff of the Council of Economic advisers — I was the senior intl economist, the senior domestic economist was a guy named Larry Summers. What ever happened to him?) was the extent to which senior government figures have absolutely no idea what they’re talking about.

So when I read something like this:

“Why should we reward Fannie Mae and Freddie Mac with $200 billion in taxpayer dollars without first reforming these housing entities that were at the heart of the economic meltdown?” House Minority Leader John A. Boehner (R-Ohio) said in a statement.

and people ask what on earth Boehner might mean when he talks about taxpayers “rewarding” institutions that are owned by taxpayers, I go for Occam’s Razor: Boehner doesn’t have some complicated notion in mind, he either doesn’t know that the government took over F&F months ago, or he just doesn’t get this “government-owned” concept.

First of all, Krugman did not even attempt to explain what exactly is supposed to be wrong about Boehner’s “stupid” statement. Whether or not he believes that the taxpayers in any way own these institutions is completely irrelevant. Let’s assume, for the sake of the argument, that they do. So what? How does this in any way invalidate Boehner’s statement. Just as a shareholder of a publicly traded private business at an annual meeting could speak out against an extension of a company’s shareholder’s equity unless the company improves its current operations, a representative of the taxpayers has the right to demand the same of a business that is held by the public trust, on behalf of the shareholders. Why in the world would anyone argue in favor of removing even this last small check on absolute power?

Now it should not surprise us that someone like Krugman gets upset about anyone asking for checks and balances when it comes to government spending. This is just another outgrowth of his small and shallow theories that favor bureaucracy and government spending anywhere and anytime. So long as we turn away from this kind of nonsense and debunk it quickly and unconditionally, no major harm is inflicted.

Regarding the issue of government ownership: The one who doesn’t get the “government-owned” concept at all is of course Paul Krugman himself. The government is a group of people that funds its operations via taxation. Taxation has always been ans will always be a form of theft. There is no way anyone can refute this simple causality.

Ownership over goods (as an economic concept) means control by one or several persons over the location of those goods in space and time. It is very different from the legal concept of ownership. Ownership over a good can come about in 4 ways: Homesteading, Exchange, Production, and Theft.

If ownership is transferred from the taxpayer to the people managing the entities in question by the means of theft, it is without a doubt a fact that the entire operation is not in the taxpayer’s interest and that the taxpayer himself won’t have any control over the allocation of the goods controlled by these entities. Thus the taxpayer doesn’t even remotely own government institutions, such as Fannie Mae and Freddie Mac. Anyone who believes that the opposite is true, should ask himself how he can have the slightest impact on what course of action these entities will pursue in future. In particular he should ask himself if he was ever asked whether or not he even wants to have any stake in them in the first place.

But all this taken aside, the most important issue with government ownership of any business is The Trouble of Bureaucracy. Any thesis promulgated by Keynesian clowns such as Krugman completely breaks down at the latest when it is confronted with the problems caused by bureaucracy.

Please note that is is more than likely that Krugman has never ever dealt with the issue of ownership in economic terms or with the theory of bureaucracy. Thus we shall exculpate him from his mistakes, but at the same time hope that others won’t blindly follow his blatant and painful nonsense.

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KrugmanWatch – A Dark Age of macroeconomics (wonkish)

In A Dark Age of macroeconomics (wonkish) Krugman writes:

Brad DeLong is upset about the stuff coming out of Chicago these days — and understandably so. First Eugene Fama, now John Cochrane, have made the claim that debt-financed government spending necessarily crowds out an equal amount of private spending, even if the economy is depressed — and they claim this not as an empirical result, not as the prediction of some model, but as the ineluctable implication of an accounting identity.

Yes, every child understands that if the government spends money it has to come from somewhere. We shall see how well Krugman does in understanding this simple causality.

There has been a tendency, on the part of other economists, to try to provide cover — to claim that Fama and Cochrane said something more sophisticated than they did. But if you read the original essays, there’s no ambiguity — it’s pure Say’s Law, pure “Treasury view”, in each case. Here’s Fama:

The problem is simple: bailouts and stimulus plans are funded by issuing more government debt. (The money must come from somewhere!) The added debt absorbs savings that would otherwise go to private investment. In the end, despite the existence of idle resources, bailouts and stimulus plans do not add to current resources in use. They just move resources from one use to another.

And here’s Cochrane:

First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both. This is just accounting, and does not need a complex argument about “crowding out.”

Yes, there is nothing new, strange, or arcane about these statements. They are simple common sense and don’t require any further elaboration.

Second, investment is “spending” every bit as much as consumption. Fiscal stimulus advocates want money spent on consumption, not saved. They evaluate past stimulus programs by whether people who got stimulus money spent it on consumption goods rather save it. But the economy overall does not care if you buy a car, or if you lend money to a company that buys a forklift.

Now here Cochrane errs: The economy does care very much whether money is spent on a consumer good or on a factor of production. The entire structure of production depends on it. How many consumer goods and how many factors of production are needed on the market is indicated to entrepreneurs via interest rates and prices. It is of primordial importance to understand this causality.

There’s no ambiguity in either case: both Fama and Cochrane are asserting that desired savings are automatically converted into investment spending, and that any government borrowing must come at the expense of investment — period.

Nobody asserts that savings are automatically converted into investment. Money might just as well be saved up by one individual without any investment on the part of this particular person. If he just saves up the money he effectively steps back from the market and leaves factors of production and/or consumer goods available for use by other entepreneurs and/or consumers. I already pointed this out in Welcome to Krugmanland.

What’s so mind-boggling about this is that it commits one of the most basic fallacies in economics — interpreting an accounting identity as a behavioral relationship.

Wrong. What is Krugman talking about now? Nobody is interpreting an accounting identity as a behavioral relationship. All that the authors have done is explain behavioral relationships as such. Cochrane may have referred to the fact that this also makes sense accounting wise, but Krugman doesn’t understand this at all.

Yes, savings have to equal investment, but that’s not something that mystically takes place, it’s because any discrepancy between desired savings and desired investment causes something to happen that brings the two in line.

It’s like the fact that the capital account and the current account of the balance of payment have to sum to zero: that’s true, but it does not mean that an increase in capital inflows magically translates into a trade deficit, without anything else changing (what John Williamson used to call the doctrine of immaculate transfer). A capital inflow produces a trade deficit by causing the exchange rate to appreciate, the price level to rise, or some other change in the real economy that affects trade flows.

Again wrong. A capital inflow represents an inflow of factors of production. When money is borrowed from abroad and used to purchase factors of production from that same country, imports increase and create a tendency toward a trade deficit without any effect on the exchange rate, especially when the government meddles with this process. More on this in The US Current Account Deficit. Krugman also conveniently mentions “some other change in the real economy” without any further elaboration. The reader himself shall decide if he believes that this kind of cursory writing is even in the slightest acceptable in an economic inquiry.

Similarly, after a change in desired savings or investment something happens to make the accounting identity hold. And if interest rates are fixed, what happens is that GDP changes to make S and I equal.

That’s actually the point of one of the ways multiplier analysis is often presented to freshmen. Here’s the diagram:

INSERT DESCRIPTIONA case of mistaken identity

In this picture savings plus taxes equal investment plus government spending, the accounting identity that both Fama and Cochrane think vitiates fiscal policy — but it doesn’t. An increase in G doesn’t reduce I one for one, it increases GDP, which leads to higher S and T.

This is all but laughable. No explanation at all is offered. We established above and at many other occasions that government spending needs to be funded by a restriction of private consumption/investment. Now Krugman “refutes” this by saying in effect: “Government expenses do NOT reduce private investment. Period.” But this doesn’t make his fallacy right. It merely shows that he has no way to argue his case on logical grounds.

Now, you don’t have to accept this model as a picture of how the world works.

OK. Thanks. Then why do you use it to argue your case. Mr. Krugman? The model is wrong. Everything derived from it is just as wrong.

But you do have to accept that it shows the fallacy of arguing that the savings-investment identity proves anything about the effectiveness of fiscal policy.

No. Wrong. We don’t have do accept a wrong thesis. There is no fallacy at all in believing that government spending has to be funded from somewhere. There is no fallacy to reject magic as the solution to our financial crisis. If anyone has to accept that his theory is a sheer fallacy, it would be Krugman himself. The fact that there is no such thing as effectiveness of fiscal policy has been shown long ago in The Trouble With Bureaucracy.

So how is it possible that distinguished professors believe otherwise?

The answer, I think, is that we’re living in a Dark Age of macroeconomics. Remember, what defined the Dark Ages wasn’t the fact that they were primitive — the Bronze Age was primitive, too. What made the Dark Ages dark was the fact that so much knowledge had been lost, that so much known to the Greeks and Romans had been forgotten by the barbarian kingdoms that followed.

And that’s what seems to have happened to macroeconomics in much of the economics profession. The knowledge that S=I doesn’t imply the Treasury view — the general understanding that macroeconomics is more than supply and demand plus the quantity equation — somehow got lost in much of the profession. I’m tempted to go on and say something about being overrun by barbarians in the grip of an obscurantist faith, but I guess I won’t. Oh wait, I guess I just did.

We do in fact live in the Dark Age of Macroeconomics. An age where Keynesian clowns such as Paul Krugman have launched a succcessful assault on logic and reason. An age where people like him are rewarded for their nonsense with Nobel Prices. An age where virtually every common sense causality suddely disappears in the sphere of economics.

Paul Krugman bears partial responsibility for this unfortunate development. It will take decades to repair the intellectual damage caused by people like him, not speaking of the damages done to people’s lives as a result of irresponsible policies of credit expansion and big government.

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KrugmanWatch – About that deflation risk

Paul Krugman is a terribly confused economist. His shallow theories justify virtually every measure of government intervention and sound palatable to the common man who seeks intellectual justification for false policies.

We shall expose his falsehoods on a regular basis in this blog.

In About that deflation risk Krugman writes:

INSERT DESCRIPTION

There has been a distinct change in tone from the Obama team today, as they seem to have become suddenly aware that there’s a real risk that the stimulus plan will either fail to pass, or be emasculated to the point that it doesn’t come close to doing the job. Obama himself has warned of catastrophe if we fail to act, and — finally!– denounced the tax-cut philosophy.

It is of course not surprising that Krugman blindly supports the common notion that there was some kind of tax cut philosophy at work under the Bush administration and that the financial crisis is proof that it failed. It is probably unnecessary to point it out again, but whoever cares to look at the actual numbers will immediately realize that all these tirades against a supposed tax cut philosophy are complete nonsense. As I explained in Obama Makes an Unnecessary Gamble:

The tax cuts were completely insignificant, the spending kept on growing. In fact, the only period in the post war history of the US where taxes where higher than now was from 1997 through 2002. That aside, taxes are at an all time high right now. So please , everyone, stop spreading the nonsense that what has happened in the past 8 years is a proof that a policy of limited government, little government spending and low taxes has failed.

So to everyone reading Krugman, assuming he is even remotely right on tax cuts, please can that notion immediately. Krugman goes on to write:

Meanwhile, Larry Summers has finally made the point I’ve been pushing for a while — that we’re at major risk of falling into a deflationary trap.

It’s at best amusing, but certainly not surprising that Krugman is about 3 years late with this realization. In fact he still talks about the possibility of a deflation. He doesn’t realize its past existence. The US had begun slipping into a deflationary period in mid 2006 already, when the True Money Supply growth had begun dropping below 3%. This was precisely when the housing bubble begun to deflate and one by one the other bubbles, viz. stocks, commodities, foreign exchange, followed. My economic indicator, the true money supply, enabled me to predict these developments a long time ago. This asset price deflation keeps going on to this date. Now, almost 3 years later, after the money supply has actually begun to grow by more than 3% again, Krugman begins to realize that there might be a deflation looming.

But worse yet, he doesn’t even know what the essence of a deflation is. A deflation is a correction of the previous misallocations created by inflation: The over-employment of resources in risky longer-term projects and an underemployment of resources in the consumer goods and basic materials industries, coupled with an over-consumption of consumer goods and a lack of capital from savings. The Business Cycle would certainly be an appropriate read for Mr. Krugman.

The worst thing the government can do is to try and fight the deflation. It will accomplish nothing but to slow the correction and create a long and painful period of adjustment, very much like the lost decade in Japan.

I thought it might be useful to present a bit of evidence behind that concern. The figure above plots an estimate of the output gap — the difference between actual and potential GDP, as a percentage of potential — and the change in the inflation rate. Both series are taken from the IMF WEO database, for convenience, and use data from 1980-2007.

It’s not a perfect fit — this is economics, not physics, and anyway stuff besides the output gap bounces inflation around from year to year. But still, there’s a clear correlation, driven largely but not entirely by the deep slump and disinflation of the early 1980s, and an implied slope of about 0.5 — that is, every percentage point by which real GDP fall short of potential tends to reduce the inflation rate by about half a point over the course of the year.

What exactly is this supposed to be evidence for? Krugman plots a change in inflation rate against a so called output gap which is supposed to be the gap between actual and potential GDP. How does he determine potential GDP? Either way, all this is based on inflation and GDP data provided by the government, data that is highly unsatisfactory and insufficient. It may be too much to ask of Krugman to expect him to have looked into alternative measures that actually provide useful information, such as True GDP. Either way, we all know we are seeing effects of a long term deflation as I explained above, Krugman doesn’t need to provide more proof for it. But he is dead wrong in viewing it as an evil.

And right now the CBO is saying that in the absence of a policy action the average output gap will average 6.8 percent over the next two years. Do the math: if anything like the historical relationship between output and inflation holds, we’re looking at major deflation.

OK, maybe that relationship won’t hold — getting to actual deflation may take a deeper slump than merely reducing the inflation rate. And maybe a regression driven in part by 80s data isn’t a good guide to current events. But deflation is a huge risk — and getting out of a deflationary trap is very, very hard.

We truly are flirting with disaster.

Yes, we are in a deflation and have been for many years. We don’t need Mr. Krugman to dwell on the obvious for us. Nor do we need to listen to his utter nonsense regarding its dangers. All we need to do is look at good data. Everyone shall decide for himself if he trusts indicators that correctly predicted future developments years ago, or if he trusts a Keynesian clown who saw absolutely nothing of this coming in time, who can do nothing but sway with shallow common notions, and apply a substantially flawed kindergarten theory whenever he needs to.

To get a taste of what expects you when reading The Conscience of a Liberal, this well qualified amazon review certainly tells a lot:

Paul Krugman continues to spin dubious conclusions from fuzzy thinking. First of all, Krugman should be discredited simply because he buys into the idea that the government has shrunk in the last few years. Anyone who thinks that George W. Bush has been an exemplar of limited government has obviously been living underneath a rock for the last eight years. The War on Terror has been a mammoth by itself, but Bush’s appointment of inflation-happy Fed chief Ben Bernanke, the Medicare Prescription plan, “No Child Left Behind”, etc. and compassionate “conservatism” in general have been every bit as welfare statist as a liberal like Krugman. Also Krugman falls for a whole lot of historical nonsense like many. For instance, he talks about the huge gap between rich and poor during the Industrial Revolution, completely ignoring the role that high tariffs, the National Banking Act, and government subsidies for numerous industries such as railroads had in the whole way. Not to mention new laws that were passed during the Industrial Revolution which exempted many industries from punishment for violating other people’s property with pollution. He claims that the New Deal is what created the Middle Class in the 50’s. Apparently someone forgot to tell him that after FDR died and WWII ended, most New Deal programs were abolished (Social Security might still be with us, but it’s headed for a collapse) and federal spending was cut by over a trillion dollars. Plus, the prospects of peace really helped out the Stock Market. Much of this and more was covered in the far more scholarly “Depression, War, and Cold War” by Robert Higgs, someone who’s far more of an economist than Paul Krugman with his discredited Keynesian ideology is.

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Welcome to Krugmanland

The science of economics is still young and full of clueless pundits. A perfect example is Nobel Price winner Paul Krugman and this article about fiscal stimuli:

I’ve been on the warpath over Germany’s refusal to play a constructive role in European fiscal stimulus. But what does the math look like? Here’s a simple analysis — well, simple by economists’ standards — of the reason coordination is so important for the EU.

We start from the proposition that Europe is, or soon will be, in a position where interest rates are up against the zero lower bound. This means both that fiscal policy is the only game in town, and that we can use ordinary multiplier analysis.

OK, I hope Krugman understands that interest rates are low because we are in phase 8 of the business cycle. That phase where people finally realize that too much has been consumed, while not enough has been saved so as to make available enough factors of production that produce those consumer goods. I hope he realizes that in order to accomplish the objectives of economic policy, viz. the maximization of every one’s well being in society, the government needs to do what is possibly can to let the market return to the state that the consumers are asking for in their value preferences and time preferences expressed in the form of interest rates and prices, respectively. We shall examine whether or not his recommendations even remotely accomplish this objective.

Let m be the share of a marginal euro spent on imports — either for an individual county, or for the EU as a whole (I’ll explain in a minute). I’ll assume that m is the same for government spending and for domestic demand. Let c be the marginal propensity to consume. And let t be the share of an increase in GDP that accrues to the government in increased taxes or reduced transfers.

Consider the effects of an increase in government purchases dG. This will raise GDP directly, to the extent that it falls on domestic goods and services, and indirectly, as the rise in GDP induces a rise in consumer spending. We have:

dY = (1-m)dG + (1-m)(1-t)c dY

or dY/dG = (1-m)/[1 – (1-m)(1-t)c]

Without any further analysis or detail Krugman implies that an increase in the nominal GDP is the ultimate objective of economic policy. He doesn’t go into any detail whatsoever. He passes in silence all the flaws that come with this figure and he certainly doesn’t ponder for a second what a true GDP measure should look like.

But all these amateurish shortcomings taken aside, let’s examine what the formula above really tells us. The idea behind the GDP is to approximate the total sum of the prices paid for all consumer goods and factors of production produced inside the country and consumed or used subsequently. The GDP Y is defined as Y = I + C + G + X – M, where
I = Private Investment (purchases of factors of production by domestic non government individuals),
C = Private Consumption (purchases of consumer goods by domestic non government individuals),
G = Government Expenses (purchases of consumer goods and factors of production by domestic government individuals),
X = Exports (purchases of consumer goods and factors of production by foreigners),
M = Imports (purchases of consumer goods and factors of production that were produced abroad)

Now Krugman tries to quantify the effect of additional government purchases dG on Y. dG(1-m) is that portion of government expenses that falls upon domestic consumption by the government. But for some reason he commits the unfortunate blunder of adding to that a mystical (1-m)(1-t)c dY. Where does that come from? He doesn’t even attempt to explain it. He simply assumes that the additional government purchases for some obscure reason also lead to more consumer demand due to an increase of the GDP which is … due to the increase in government expenditure. This is complete utter amateurish kindergarten nonsense.

Krugman is an intelligent person. He must have missed something here. If he wants to figure out whether or not an increase in government expenses leads to an increase in GDP then how can he commit the blunder of assuming an increase of GDP in that very same formula. This is something that not even an elementary class student would get away with. If he wants to apply the questionable GDP formula to calculate the effect of government expenses on the well being of society he should at least do that right.

First of all one has to understand, as most people hopefully do, that dG does not simply grow out of nowhere. Additional dG will have to be funded out of additional taxes. Taxes are funded by taking money from private individuals. If money is taken from private individuals it will either reduce private consumption C or private investment I or both of them by precisely the amount spent. The basic culprit is that Krugman uses variables that are dependent upon each other in the same formula. When one starts calculating derivatives for such a formula one must take that into account. Thus the following calculation is the only correct one:

Y = G + (I + C ) + X – M
<=> dY = dG(1-m) + (dI + dC dG(1-m)) + dXdM
<=> dY/dG = 1-m + 0 + 0 – 1 + m + 0 – 0
<=> dY/dG = 1-1
<=> dY/dG = 0

Of course he has to resort to complicated and sophisticated looking mathematic formulas because if he were to explain his hideous theory in words it would break down immediately.  Even if we give Krugman the benefit of the doubt, the growth in GDP, if the government spends dG, would be exactly 0. This is the one and only correct way to calculate a change dY/dG if one understands basic elementary school mathematical concepts and if one applies simple logic and reason. Paul Krugman needs to come forward and apologize for his terrible blunder.

Even if an individual were to work and save 50% of his earnings in cash in his matress, he would not inflict the slightest harm upon his fellow men. All he does in working and saving is make available more productive capacity to everyone than he in return withdraws via consumption. By withdrawing his money and saving it for future consumption he steps back and voluntarily leaves factors of production or consumer goods available to others by not participating in the bidding process on the market. The prices for those goods would thus be lower than had he participated, but they still render the same benefit to the consumers. If the government steps in and buys the good in question, it does nothing but snatch it away from someone else and employ it in bureaucratic uses. The Trouble With Bureaucracy explains what will inevitably ensue. No one is helped in this process, only harm is inflicted.

Now, I know that a Keynesian such as Krugman would now object that the additional government expenses would not necessarily have to be funded out of taxes but rather via deficit spending. OK, let’s say the government borrows additional money from one of the participants on the market. Again, this would require that someone who would have loaned the money to someone else now loans it to the government in a credit transaction. The money will thus not be available to that marginal entrepreneur who would have borrowed it. Private investment is reduced while government expenses go up. From the kindergarten GDP formula’s point of view, the effect is 0. To those who understand bureaucracy, the effect is negative.

The diligent pseudo economist, who has meticulously studied all of Keynes’s shallow theories, will then reply: “But since we are approaching 0% interest rates, no one will lend the money, everyone will hoard it. We are in a liquidity trap!” Then we would have to reply that since we are in phase 8 of the business cycle, of course people are hoarding money. The reason being a reckless monetary and fiscal deficit spending policy. And the only way to get out of it is to swiftly abandon that policy and let phase 9, the correction, occur. But even that taken aside, what I said two paragraphs above, applies just as much in this case again. There is no way around this causality, no matter how much one tries to deny it.

Then the Keynesian will reply that the added government expenses could also be funded by having the government print money and buy goods on the market. And of course the response to that would have to be that in that case, money prices for the good purchased with the fiat money will go up and, again, will force the marginal consumer to forgo consumption of that good, while it is re-allocated to the government. The Keynesian would then reply that no one would have purchased the good if the government would not have purchased it. To that we would again have to explain to the Keynesian the basic concepts of he function of a price and that a good will be demanded at a certain price, so long as that price represents the involved parties’ value preferences. If it doesn’t then the seller needs to lower the price until it does.

But even if the price for the good was 0, what good does it do if the government prints money and gives it to someone who in return has produced a good that nobody needed? He will be the first to receive this money and bid up the prices of goods that would then not be available to other marginal consumers who would have bought it in exchange for money earned from useful labor. They will then abandon their operations which the consumers deemed useful and also begin producing that same useless good in order to obtain free money from the government. The business cycle will inevitably ensue.

It is impossible to run away from the fact that government expenses will be wasteful and by necessity lower the people’s standard of living due to the irrefutable workings behind bureaucracy. The crucial shortcoming of applying the GDP formula is the blatant disregard of the fact that the government raises money violently and against the people’s value preferences before offering goods and thus faces the inability to calculate profit and loss.

Since governments are worried about debt, it’s also important to ask how much the budget deficit is increased by an increase in government spending. It’s not one-for-one, because higher spending leads to higher GDP and hence higher tax revenue. We have

dD = dGtdY

Now he continues with the false assumption that GDP is growing and happily concocts new formulas based on that. He doesn’t put into context the relevance of dD and, I have to assume, does not bother to view it in light of a corresponding reduction of private investment which would necessarily occur as I already pointed out above. He blithely assumes that magically a tdY appears out of nowhere and reduces the deficit. He then takes this flawed formula and incorporates it into his other flawed formula. Everything from hereon is based on sheer nonsense and requires no further comment:

A crucial number is “bang for euro”: the ratio of the increase in GDP to the increase in the deficit. After a bit of grinding, it can be shown to be

dY/dD = (1-m)/[1 – (1-t)(1-m)c – t(1-m)]

OK, some numbers. The average EU country spends about 40 percent of GDP on imports, and collects about 40 percent of GDP in taxes. Let me cut corners and assume that the marginal rates are the same as the average, and also assume that the marginal propensity to consume is 0.5. That is, for an average EU country, m = 0.4, t= 0.4, c = 0.5.

We can represent a coordinated fiscal policy by looking at the numbers for the EU as a whole. The only difference is that m falls to 0.13, because two-thirds of the imports of EU members are from other EU members.

And we get the following results:

UNILATERAL FISCAL EXPANSION

Multiplier = 0.73
Bang per euro = 1.03

COORDINATED EXPANSION

Multiplier = 1.18
Bang per euro = 2.23

The bang per euro is what matters: the tradeoff between increased debt and effective stimulus is MUCH better for the EU as a whole than it is for any one country.

You can play with these numbers, but I don’t think that conclusion is very sensitive to the details as long as you keep the large intra-EU trade effects in there. The lesson of this algebra is that there are very large intra-EU externalities in fiscal policy, making coordination really important. And that’s why German obstructionism is such a problem.

Krugman can’t escape the fact that his formula fails from start to finish. It sickens me that thousands of students are probably listening to him and employing his “logic” elsewhere. To anyone who still doubts my criticism, please consider the following: If the bang per Euro of deficit spending is 2.23 Euro, then why don’t we ask all European governments to spend 1,000 quadrillion Euros on deficit. This will create unprecedented wealth in Europe of 2,230 quadrillion. Then the governments can levy a tax of 1,000 quadrillion and pay off the debt. With 1,230 quadrillion Euro, this would leave Europe wealthier than ever before for years and years to come. Welcome to Krugmanland!

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