Paul Krugman: Shrugs Off Long-Term Effects Of Deficit

Last Sunday, Nobel laureate Paul Krugman delivered a disturbing short-term paradigm in his Dwindling Deficit Disorder: “Right now, a sustainable deficit would be around $460 billion. The actual deficit is bigger than that. But according to new estimates by the budget office, half of our current deficit reflects the effects of a still-depressed economy. So we do not, repeat do not, face any kind of deficit crisis either now or for years to come. There are, of course, longer-term fiscal issues: rising health costs and an aging population will put the budget under growing pressure over the course of the 2020s. But I have yet to see any coherent explanation of why these longer-run concerns should determine budget policy right now.”

With all due respect, Krugman, we don’t need a coherent explanation other than common sense. “Longer-run concerns” should always determine “right now” policy. No good can come of applying delaying tactics, so putting off obligations until later will only worsen the deficit.

Americans need to understand that there is nothing like a free lunch. At some point, you will have to face the consequences of decades of irresponsible entitlement promises that the government could never afford.

It is envisaged that the most dangerous antidotes will keep emanating from Krugman’s short-range rationality. Therefore, I will debunk three myths, which manifest repeatedly in his New York Times articles. The purpose is to abandon Krugman’s black swan denial and as such, to give you a reasonable argument that the dot-com bust, the housing bubble and the subsequent financial crisis were all quite predictable. If you understand the following line of argumentation, you will be able to help us (Krugman averters) shift the Overton window and as such, help us prevent the upcoming dollar crisis.

The first myth is that short-ranged spending strategies, misaligned monetary expansion (skewed from productivity growth) and artificial low interest rates can bring about sound and sustainable solutions to business cycles. The two charts below from the housing sector suggest that these sorts of short-ranged interventions bring nothing but ephemeral sugar highs. They do bring prosperity, but are not sustainable overtime. The reason is very straightforward: these sorts of interventions generate a lot of white noise, misleading investors towards investments that are not really profitable. The phony prosperity is based on incorrectly allocated investments and the inflated bubble eventually bursts. Therefore, more spending and QEs (the Krugman antidote for today’s recession and the dot-com bust) cannot be the cure.

Source 1 Seeking Alpha: "Employment and the Housing Sector"

Serious economic analyses should always prioritize policy reforms based on sound money and long-term objectives. “Right-now” budget policies should always consider the future welfare of our society, even when that medicine tastes bad today. That is the responsible paradigm. An aspirin may taste OK and bring the temperature down, but it won’t cure the disease. A penicillin shot will taste awful today and hurt like hell, but will most likely kill the original bug.

On January 17 Krugman proved once again this unsettling short-range philosophy in his (unsurprisingly similar title) Dwindling Deficit: “The long-term outlook gets much more attention than it should.” “But neither the current deficit nor projected future spending deserve to be anywhere near the top of our political agenda. It’s time to focus on other stuff…”

Translation: why worry now, if we can easily kick the can and give our “long-term” fiscal issues to our children and grandchildren?

The Federal Reserve Bank of Minneapolis has constructed a fascinating interactive webpage where citizens can play with and have a firsthand taste of different recessions and recoveries from the past century. The next charts portray the effects of two different antidotes from two different administrations, but with one thing in common: both inherited recessions. These graphs compare the aftermath effects (on output and employment) of the short-range Obamanomics aspirin versus the long-range Reaganomics penicillin:

I am no fan of the supply-side Reaganomics either. And the reason is very simple: supply-side intervention did not allow Reagan to stop the spending soaring spiral. Richard Ebeling suggests that during the Reagan administration “the macroeconomic manipulators have now discovered there is a new set of economic equations that can be massaged on the ‘aggregate supply’ side as well.” Murray Rothbard demonstrated that Reaganomics was a new alternative for Keynesians to run the economy.

I couldn’t agree more, however, if we put the numbers in perspective, we can see how the supply-side treatment was less destructive and more sustainable, in the long run, than the demand-side antidote (which Krugman continues to sell).

How could this difference be explained? Unfortunately for Krugman and the demand-siders, when it comes to innovation and productivity, governments have an awful track record compared to the private sector. When governments tax (to increase spending and re-activate the economy, or to engage in productive activities that generate wealth), it must steal resources form another (more productive) sector.