Keynes and Krugman

Paul Krugman writes in the NY Times about the battle currently raging in the economics profession between the fresh-water devotees of the Chicago school and the more Keynesian salt-water economists, of which he is a partisan.

"But don’t recessions look like periods in which there just isn’t enough demand to employ everyone willing to work?" Well, I sure want to work and no one will hire me. I want to work as a hammock sleeper. I'm good at it. I've trained for years. Minimum wage would be fine, even though I've got a family to feed, but no one will hire me. It's a case of inadequate demand! The government should rectify this situation at once!!

A joke? OK, but I don't want a minivan. I don't know anyone who does. They're big and ugly and burn lots of expensive fuel. Yet, the car companies are busy crying for government bailouts. But, maybe the mistake isn't inadequate demand for ugly gas guzzlers. Maybe it's inadequate ability to make cars people want. I don't see how their argument is any different than my failure to find employment sleeping in a hammock.

Guided by this neo-Keynesian thinking, the government is pumping out billions in stimulus money. My fear is the most of it will go to politically connected boondoggles, bridges to nowhere, or well intentioned but fluff-headed projects. The problem was that we as a country spent too much by taking out too much credit. We're trying to wise up and spend less and save more. That's to be encouraged.

I should read Keynes, just to know whether his work is misquoted and abused as badly as Adam Smith's. My guess is that both sides of this neo-Keynesian vs. rational-market argument contain valuable insights. But the belief that either theory is the anywhere near the whole explanation seems woefully contradicted by the facts. And arguing one dogma vs. another is a sure way to miss whatever new insights this current mess can show us.

To justify spending our way out of recession, Paul Krugman says (in the Aug. 27, 2009 NY Times) that a debt-to-GDP ratio of 70% is OK for the US. That means 1% of GDP goes to interest on the debt. He sites examples of Belgium and Italy which had debt-to-GDP ratios of 118 and 114 percent in the early 1990s. Japan's is upwards of 170%.

He says, "The United States can deal with its debts if politicians of both parties are, in the end, willing to show at least a bit of maturity." Feel safe with that assumption?

But, let's juxtapose that with the International Monetary Fund's report on Argentina's financial collapse (The IMF and Argentina, 1991-2001 By Shinji Takagi). (I don't really know if these ratios are computed the same way.)

[The] debt level of 50% of GDP was high for any country, but particularly for Argentina, given the likely overvaluation of the peso. With the sharp depreciation of the peso against the U.S. dollar, in the event, Argentina's external debt-to-GDP ratio rose to over 140% in 2002.

I don't mean to beat up on the Nobel prize winning Krugman. I like his essays and often agree with them. But the idea that more spending and more debt can possibly be the answer to a crisis brought on by too much spending and too much debt is a little hard to swallow. Maybe I'm just a grumpy old crank who thinks the world is going to hell in a hand-basket, but I'm worried that commenter, Chris Horton, might be right:

This country is toast... For my entire lifetime, the GOP have been despicable scum and the Dems worthless fools. The lights are going out all over America, we shall not see them again in our lifetime.

On a related note, Justin Fox's The Myth of the Rational Market sounds like a fun read. Krugman liked it. And EconTalk has an interview with the author.