It is well known that Paul Krugman has morphed from Nobel Prize winning columnist into something else. Nonetheless, it is still fun to analyze what he is saying when he pretends to be wearing his economist hat. Take for example the issue of whether or not we should be worrying about having a debt to GDP level that is roughly 100% – the highest we have seen since WWII and the largest peacetime debt to GDP level in history. Now, there are reasons both to be worried and not to be worried, but that is not my point.
In this piece Krugman argues that one reason (correctly) you might not worry is that “markets” do not appear to be worried about the high debt levels. The Treasury is auctioning off short-term debt for nearly 0 percent interest, and while the yield curve is upward sloping, interest rates on even the longest-term instruments are very low by any standard. If “markets” were spooked at the prospect of government default or fear that the Fed will monetize the debt, you would expect interest rates to turn sharply against the government’s favor (i.e. they should rise to reflect the increased risk of lending to a shaky government). But Krugman correctly points out that we do not observe this (my view is that this just means that the U.S. is the world’s tallest midget, but that is for another day).
To summarize, there is no need to worry about the huge US debt burden because markets rationally are not worried, and if that it seems to be a problem, we can look to market behavior to indicate when it is a problem. Agreed. Perhaps.
But then think back to Krugman’s criticisms of the crisis, and his general thinking about how “Depression Economics Changes the Rules.” One thrust of his argument is that markets fail because they are irrational. Markets fail because they under-price risk. Markets fail because they lack proper information to understand some of the activities market participants are engaged in. And since markets fail due to these problems, the omniscient planners who are all well versed in the General Theory can swoop in to save the day with a little (or a lot) stimulus and viola, the problem is solved.
Do we see the problem here? When the conclusions drawn from market rationality are favorable to larger government, then Mr. Krugman appears to be a Chicago-style economist. When the conclusions drawn from market rationality are not favorable to larger government, well, then, he resorts to arguing that markets are not rational. So, markets are rational when he wants them to be, and irrational when he wants them to be. How’s that for science?
Great observation, his misuse — no, abuse bec/ he knows better — of economic reasoning is astounding and probably missed on most folks.
But getting back to the point about the debt, since you raised it in pointing to Krugman’s blatant hypocrisy. It is my observation as a practicioner (money manager) that people (investors) are really scared. Not by the debt per se, but by the GOVT SPENDING. They know we will be taxed now or later to pay for it, so they are NOT SPENDING in anticipation of higher taxes — they have told me so explicitly. Anecdotal, but that’s all I’ve got to go on. So doesn’t this explain perhaps why the “stimulus” effect goes “poof.” Just my amateur economic analysis.
And a great observation by JB as well. Robert Barro and others are routinely slammed for arguing in favor of the “Ricardian equivalence” idea. The idea was originally put forth to illustrate that it did not matter whether governments financed spending out of current or future taxes – in either case, consumers would respond rationally. If you finance with current taxes, current consumer spending must fall because of the reduced take home pay of individuals. If you finance with future taxes (which is what running deficits does – because to pay the accumulated debt requires an increase in future taxes) then people rationally will reduce spending today so that they will have the funds to pay the taxes tomorrow.
perhaps you might be too modest in saying what you see is “anecdotal.” At least it is one data point – which is one point more than most every critic of the Ricardian equivalence idea cares to present.
Send this to Niall Ferguson