I've been a pretty ardent defender of Paul Krugman as I've explored online political advocacy and discourse over the past couple years. I really like his fundamental proposition that political economy should be accessible to all citizens; he is one of the few academicians to care about connecting with a mass audience and be successful at doing so. On top of that, I happen to agree with many of the positions he takes, which is quite a pleasure compared to most who have access to the corporate media megaphone.
In this piece, I want to add some context or commentary to the much-discussed posting that Krugman made on his New York Times blog regarding deflation this week. I really don't disagree much with anything that was said, technically. However, I think it leaves an incomplete picture when not placed in the context of our times, which is the massive credit bubble that expanded debt far beyond reasonable or sane - or sustainable - levels. That which is not sustainable tends to cease, sooner or later.
Krugman lays out three important reasons for why deflation is bad.
So first of all: when people expect falling prices, they become less willing to spend, and in particular less willing to borrow...And when that happens, the economy may stay depressed because people expect deflation, and deflation may continue because the economy remains depressed. That’s the deflationary trap we keep worrying about.
A second effect: even aside from expectations of future deflation, falling prices worsen the position of debtors, by increasing the real burden of their debts.
Finally, in a deflationary economy, wages as well as prices often have to fall – and it’s a fact of life that it’s very hard to cut nominal wages — there’s downward nominal wage rigidity. What this means is that in general economies don’t manage to have falling wages unless they also have mass unemployment, so that workers are desperate enough to accept those wage declines.
Unlike most critics of Krugman (from the right), I'm not critical of the embrace of 'Keynesiansim' (whatever such term has come to mean, depending upon whom you ask). Rather, I think Krugman doesn't fully embrace his own advocacy. His position of needing to be an expert taken Seriously by the gatekeepers of Conventional Wisdom prevents him from just coming out and saying the logical conclusion - preventing a shrinking money supply will require huge amounts of money.
This is likely because Krugman has taken tremendous amounts of heat from Democrats for pointing out even simple, obvious things, like ARRA (the stimulus) being too small. For example, Krugman wrote this back in January, 2009:
But only about 60 percent of the Obama plan consists of public spending. The rest consists of tax cuts — and many economists are skeptical about how much these tax cuts, especially the tax breaks for business, will actually do to boost spending. (A number of Senate Democrats apparently share these doubts.) Howard Gleckman of the nonpartisan Tax Policy Center summed it up in the title of a recent blog posting: “lots of buck, not much bang.”
The bottom line is that the Obama plan is unlikely to close more than half of the looming output gap, and could easily end up doing less than a third of the job.
Why isn’t Mr. Obama trying to do more?
Our situation isn't some run-of-the-mill business cycle driven recession. We are in a massive mean regression wherein balance sheets that have soaked up way too much debt (given wage stagnation) over the past generation need to work off huge amounts of credit that has been extended to them. And remember, no matter what the supply-siders tell ya, we're talking private balance sheets in America; government debt is not (yet) the main problem.
A little bit of expansion of the money supply (inflation) is irrelevant. It's a bit like saying driving 11 miles per hour is 10% better than driving 10 miles an hour. That's true. But if you're trying to drive from Atlanta to Chicago, that will take you a long time at 11 miles per hour. The increase is insignificant given the scope of the task at hand - nevermind the logistical hurdles of executing such a trip.
We are confronted with several possible choices which overwhelm the textbook description of the deflation problem that Krugman describes. The first is a debt jubilee: we write down the massive amounts of debt to their actual value, that which can be supported by wages. This will require creditors - ie, in aggregate, rich people - to take major losses. Second, we could hand out massive amounts of money. If given to rich folks, it's trickle down economics, and if given to all Americans equally, it's socialism. Third, we could simply let the deflationary trap take hold - the 'do nothing' approach which always seems the baseline against which the supporters of trickle down economics measure their success.
The thing is, two of those options are actually reasonably good, given the alternatives presented by the other two.
However, our public policy has embraced the other two. When it comes to the good options, on the credit bubble, we have done virtually no writing down of debt, and on handouts to all Americans, we have done little more than the $600 tax rebate gimmick back in 2008.
When it comes to the bad options, though, we've done them in spades. On the doing nothing front, that's exactly what we've done related to employment. Sure, there have been some minor tweaking and extensions of programs like SNAP and unemployment insurance - and that's good, 'better than nothing'. But this amounts to little more than pocket change. Millions of unemployed workers aren't eligible for any unemployment insurance at all. And we have done little as well to invest in our future in ways that just so happen to also put people to work - like repairing infrastructure and building comprehensive transit systems.
But the do-nothing front pales with the worst reactions to the financial shenanigans: giving fistfuls of cash to the wealthy. This is the absolute worst way of dealing with a deflationary trap (for everyone other than the wealthy, of course). It gives creditors more power relative to debtors at precisely the moment when debtors need to be renegotiating their payments to creditors. It transfers wealth upwards when wealth concentration is a key explanatory variable for why things got so bad to begin with. It engenders distrust and disgust of government at precisely the time when government is most needed to guide us through the turmoil.
And it's an insult to basic economics; if you're trying to stimulate demand, you look at marginal propensity to consume - in other words, how much is going to be circulated into the economy. Marginal propensity to consume is highly negatively correlated with wealth. Poorer people spend a lot more of their next marginal dollar than richer people. That's why programs like SNAP and unemployment insurance are also such good 'bang for the buck' - they get the bucks to people who actually need them. That's why infrastructure and similar investments are better returns than tax cuts, because middle income workers put more of their income to work in the economy than wealthy recipients.
In short, the enormous size of the credit bubble means that if inflation is the answer, then the money supply has to be expanded a lot in order to prevent debt defaults. A 3% or 4% rate of inflation over the next couple years won't solve anything; we're talking trillions upon trillions of dollars that the shadow banking system created, and if government money printing is going to fill that balloon (rather than letting it deflate), then we'll need a lot of money. Don't get me wrong: we could do that, if we wanted to. Underestimate the power of the government printing press at your own peril. The important observation is that money printing (no matter its form) involves choices about who wins and who loses. The Fed, Treasury, and others have to give the money to somebody in order for it to get into circulation.
So far, The Powers That Be are winning. They're being given the money when they're the ones who crashed the system. That's worse than the consequences of deflation. While Krugman can point out the problems with a shrinking money supply, he can't seem to bring himself around to an inflation solution that would actually address the magnitude of the problem, like mailing $100,000 checks to every American, or opening bank accounts with $100,000 balances in the names of every American, or creating Treasury Direct accounts with $100,000 worth of Treasury securities in the name of every American.
So, we're left with fiddling around the margin, as if the difference between 4% deflation and 4% inflation is meaningful in a time when most people can't pay their home mortgages, college bills, or auto loans while a few Americans are so wealthy they have nothing to do with their money but go gambling. Deflation is painful, but trickle down economics is catastrophic.
Crossposted at The Seminal at FDL.