Paul Krugman expresses frustration that “austerians” keep using bad arguments:
[We Keynesians are] not always and everywhere against fiscal consolidation; give me the right economic circumstances and I’ll turn at least modestly deficit hawk. We are, instead, against austerity when the interest rate is against the zero lower bound, because when the economy is in a liquidity trap the contractionary effects of fiscal tightening can’t be offset by monetary expansion.
I don’t agree that monetary policy is out of ammunition at the zero bound, and if you read the entire post it seems even Krugman doesn’t think the ECB is out of ammunition:
Let me venture a guess: it may have a fair bit to do with the ECB’s narrow mandate. In America, the Fed explicitly had a dual mandate, which charges it with achieving full employment as well as price stability; this makes it natural to consider the difference being at the zero lower bound makes. In Britain, for whatever reason, the BOE has proved willing to tolerate above-target inflation for a while, and public policy debate does tend to focus on what the BOE can do to offset austerity. But in Europe, the ECB just doesn’t talk about its responsibility to stabilize the real economy, and how the liquidity trap in the European core may be compromising its ability to do so.
Nor is it just failure to talk; let’s not forget that the ECB actually raised rates in 2011, despite high unemployment, and has consistently refused to cut rates even as Europe slides deeper into double-dip recession — and as Europe as a whole moves ever deeper into fiscal austerity.
So what I’m arguing, I guess, is that the EC obtuseness on fiscal policy is derived in part from the broader European obtuseness on monetary policy. Still, it’s quite a remarkable thing: we’re five years into this crisis, and key European policy makers still talk as if they were unaware of the central argument their critics have been making from day one.
I strongly agree with all these points:
1. The ECB has the wrong target (inflation only.)
2. The ECB raised rates in 2011.
3. The ECB “has consistently refused to cut rates even as Europe slides ever deeper into double-dip recession”
What I don’t understand is how the inflation-targeting ECB wouldn’t simply offset any additional fiscal stimulus, or at least the demand-side effects of additional stimulus. Nor do I understand how a central bank that refuses to cut rates could be said to be out of ammunition. Are PIIGS bond yields at zero? And even if rates were at zero, is the ECB out of paper and ink?
Yesterday he did a post on a similar issue:
So, start with our big problem, which is mass unemployment. Basic supply and demand analysis says that things like that aren’t supposed to happen: prices are supposed to rise or fall to clear markets. So what’s with this apparent massive and persistent excess supply of labor?
In general, market disequilibrium is a sign of prices out of whack; and most people commenting on our mess accept the notion that one or more prices are for some reason not adjusting. The big divide comes over the question of which price is wrong.
As I see it, the whole structural/classical/Austrian/supply-side/whatever side of this debate basically believes that the problem lies in the labor market. (I know, the Austrians will deny it — but it doesn’t matter what you say about their position, any comprehensible statement leads to angry claims that you don’t understand their depths). For some reason, they would argue, wages are too high given the demand for labor. Some of them accept the notion that it’s because of downward nominal wage rigidity; more, I think, believe that workers are being encouraged to hold out for unsustainable wages by moocher-friendly programs like food stamps, unemployment benefits, disability insurance, and whatever.
As regular readers know, I find this prima facie absurd — it’s essentially the claim that soup kitchens caused the Great Depression. But let’s stick with the economic logic for now.
Notice that Krugman doesn’t address the sticky price argument at all. To be fair, lots of conservatives make the “disincentive to work” argument, but it’s certainly not the only justification for believing wages might be at the wrong level to clear the labor market. Then he switches to an interest rate argument, without explaining what’s wrong with the sticky wage theory:
So what’s the alternative view? It’s basically the notion that the interest rate is wrong — that given the overhang of debt and other factors depressing private demand, real interest rates would have to be deeply negative to match desired saving with desired investment at full employment. And real rates can’t go that negative because expected inflation is low and nominal rates can’t go below zero: we’re in a liquidity trap.
I certainly do understand this argument, but I find it frustrating how he seems to slide seamlessly from one issue to a completely separate issue. The first tissue is; “Why do nominal shocks have real effects?” And I think sticky wages are a pretty reasonable answer. The second question is: “Why did the Fed allow a large negative nominal shock to occur?” And the zero lower bound is certainly a plausible theory of Fed Fail. As readers know I think the zero bound is not truly a “trap;” the Fed can reflate by setting a higher NGDP growth target and committing to buy as much debt is is required to equate market expectations with the target. Nonetheless, I agree that the actual behavior of the Fed was almost certainly at least somewhat restrained by their queasiness over adopting aggressive unconventional policies. So the zero lower bound matters in that sense. But this is wrong:
There are strong policy implications of these two views. If you think the problem is that wages are too high, your solution is that we need to meaner to workers — cut off their unemployment insurance, make them hungry by cutting off food stamps, so they have no alternative to do whatever it takes to get jobs, and wages fall.
No, if wages are too high, and wages are sticky, then the solution is to raise NGDP. I favor straight monetary stimulus, but if that won’t work then even a helicopter drop would be preferable to waiting years for wage cuts to restore equilibrium. You can believe wage stickiness is the root cause of unemployment, and also favor the sort of AD stimulus that Krugman would regard as “progressive.”
At times Krugman seems to suggest there are only two views; his view and that of the right wing crazies. Of course there are heterodox on both sides (some leftists also oppose the Fed’s “easy money” policy.) And there are (monetarist) supporters of monetary stimulus who see sticky wages as the root cause of cyclical unemployment.
I also take exception to this claim:
Oh, and one more thing: no, you can’t say “Well, there may be truth to both views”. Either the economy is supply-constrained or it’s demand-constrained. Of course even the most ardent demand-siders will admit that there are supply constraints in there somewhere, that if we had an economic boom we would, after some period of time, enter a regime where printing money is inflationary and government borrowing drive up interest rates. But not here, not now.
I certainly agree that demand has been the biggest problem since 2008. But I see no reason why both the AD and SRAS curves can’t shift left at the same time. And if they do, the drop in employment would be even greater than if only the AD curve had shifted left.
There’s more to life than old-style Keynesian stimulus and austerianism. In the first post I linked to Krugman expressed frustration that people weren’t paying attention to his views:
So do the austerians reject this argument? No — they basically fail even to acknowledge that it exists.
As a market monetarist, I know how he feels.
PS. Just so the post doesn’t seem like a mindless anti-Krugman rant, let me add that I do agree with Krugman’s view that the recent David Stockman column was a sort of mindless rant. And I’m an expert on rants. 