NEW YORK—Paul Krugman is perhaps the most well-known voice of neo-Keynesian economic theory. In a discussion hosted by 92Y in New York on Jan 27., he lived up to his reputation and called for the government and the Federal Reserve to spend and print more money.
“What’s key to the economy is a couple of public works projects that create jobs,” said Krugman. The Princeton professor and New York Times columnist follows the Keynesian school of economics which propagates government spending when private demand is faltering.
After the financial crisis of 2008, consumers and businesses have largely shut their wallets and paid down debt, leading to a slump in spending. Unemployment and anemic wage growth have further reduced consumer spending power. Since the U.S. economy is 70 percent consumer-driven, this is a major reason for the sub-par recovery.
“It’s still terrible,” Krugman said regarding the economic recovery, as he singled out unemployment as a major problem. He said that policy makers wrongly believed the 2008 crisis was just a banking crisis and not a crisis of consumer demand. “Policy makers don’t believe that economic stuff unless it suits their prejudices,” as he criticizes both political parties and the Obama administration.
“We still don’t have any kind of vigorous recovery. It would have been possible to get through some more [stimulus] in late 2009, when democrats still controlled both houses of Congress,” says Krugman.
However, the author of “Depression Economics,” who won the Nobel Memorial Prize in economics in 2008 for his work on New Trade Theory, says the government did one thing right.
“You had to rescue the financial system. In that sense [Treasury Secretary Tim] Geithner was right. Something like the TARP had to happen. It was pretty much inevitable that by doing that you were going to help out some people that didn’t deserve help,” he says, implying that the banking sector got away too easily. He thinks the banks were responsible for the financial crisis due to “Wild West capitalism” and speculation, which fueled the housing bubble.
“We should have had taken a Citigroup into receivership. Just to make clear: ‘You’re not going to get off scot-free,’” Krugman says about the bailout of major banks such as Citigroup Inc., which received large amounts of public capital without the need to relinquish private control of the organization. According to Krugman, there is still a chance in the future: “I would like to see the banks punished some more.”
More Money-Printing to Enable Stimulus Spending
Despite not having “a lot of grand visions for the next four years,” Krugman says that President Obama should increase government spending and money-printing to solve the demand problem and return to economic growth.
Krugman envisions large public works projects and government hiring, naming teachers as an example. For Krugman, high fiscal deficits and public debt are not a big concern.
“I wouldn’t worry about fiscal policy until unemployment falls below six percent,” he says, hinting at the fact that the Federal Reserve will continue monetizing government debt, or “print money,” until the unemployment rate falls below 6.5 percent.
As long as that is the case, there should in theory be no problem of financing government debt. Furthermore, the theory propagates that low unemployment and higher growth will boost tax revenues.
Critics, however, say that one cannot infinitely drive up debt without consequences.
“My response to that is that’s how we got into that mess right now. At some point [the debt to GDP ratio] is going to become dangerous… Krugman can say that we don’t know what the numbers are, could be better could be worse. I would say that it could be worse,” former Secretary of the Treasury Robert Rubin said at an earlier talk when asked about Krugman’s philosophy.
Rubin, who had been an executive at Goldman Sachs and Citigroup, thinks that money-printing and high government deficit will cause another financial crash. “You could have a substantial dislocation in the bond market and then you would likely have a distortion in the stock market as well,” he commented, saying that people would drive up bond yields because they are concerned with inflation.
No Free Lunch
Critics of the Keynesian school are wary of the “something for nothing” mentality and fear the consequences of money printing.
“There has to be a change in social mentality—so that people realize that nothing is free, and the government has to shrink,” Pedro Schwartz, a Spanish professor of economics who follows the Austrian school of economics.
According to Schwartz, no effort is required when the Fed prints money and the government spends it. This is opposed to the way a normal economy functions where taxes on actual productive activity result in government revenues which can then be spent on communal goods.
Kyle Bass, owner of hedge fund Hayman Capital, also warns of the consequences of fiscal deficits and money printing. He writes in his latest letter to investors: “Central bankers are feverishly attempting to create their own new world: a utopia in which debts are never restructured, and there are no consequences of fiscal profligacy.”
“We have a hard time understanding how the current situation ends any way other than a massive loss of wealth and purchasing power through default, inflation or both,” Bass says.
Bass’s comment is in reference to the phenomenon that stimulus spending is often unproductive. It does not create the real economic activity that would make it possible for the debt to be paid off naturally. Normally, without central bank intervention, bond investors would sell the bonds of a country that spent the money on unproductive investments, thus forcing policy makers to change course.
According to Bass, the current central bank intervention takes away this check on government spending and leads to inflation. “This market phenomenon does nothing to encourage the body politic to take their foot off the spending accelerator. It is both our primary fear and unfortunately our prediction that this quixotic path of spending and printing will continue ad-infinitum until real cost-push inflation manifests itself.”
According to Krugman, runaway inflation won’t happen as long as unemployment is low and there is excess capacity, keeping a lid on the prices for labor and capital. Once the economy is back on track, stimulus measures can be reversed before inflation kicks in.
He is confident that policy makers can manage inflation despite most historical examples pointing to a less fortunate outcome. Once government debt reaches a certain threshold and the central bank is used to monetize the debt on a large scale, such as in the Weimar Germany, hyperinflation is the inevitable outcome.
“Those things can be turned around pretty quickly,” Krugman says about government spending programs and also thinks that his former Princeton colleague Ben Bernanke has what it takes to tighten monetary policy at the right time: “Uncle Ben can raise interest rates pretty quickly.”
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