Paul Krugman: Right Idea, Wrong paradigm
Wednesday, 12/2/2009 - 5:40 pm by Marshall Auerback | 17 Comments
Marshall Auerback explains why ‘deficit doves’ may be doing as much harm as ‘deficit hawks,’ and calls for a government jobs program that will get our economy back on track.
Paul Krugman is right: the job market is terrible right now and we do need measures which will promote immediate employment growth. This is no time for empty slogans like “unemployment is a lagging indicator”. The President says this to comfort us, but it’s cold comfort to those struggling to keep their homes and feed their families.
Fortunately, there is an easy solution. More jobs are required. If the private sector cannot produce these jobs, then who can fill the gap? It can only be the government, since the government does not face the same kind of funding restraint as a private individual or business.
Deficit hawks are wrong.
For all of those who fret about our deficits, we would remind them that we have an official unemployment rate of 10.5 per cent at the same that 30 per cent of our production capacity lies idle. More people are using food stamps than ever before — a program once scorned as a failed welfare scheme now helps feed one in eight Americans and one in four children. Whatever measures we have taken so far are massively insufficient. It is, as Paul Krugman suggests, a national emergency.
Unfortunately, even Krugman still falls prey to the siren songs of the deficit terrorists. He calls for a “cheaper program.” Maybe he accepts the notion that the government can “run out of money.” Or perhaps he thinks that running larger deficits will cause prices to become unstable. He frets that his suggested programs will cost huge sums of money, “probably several hundred billion dollars, and raise the budget deficit in the short run. But this has to be weighed against the high cost of inaction in the face of a social and economic emergency (our emphasis).”
Inflation is not our immediate concern.
That’s nonsense. There is nothing to be “weighed against”. Caution is only warranted when there is inflation, and inflation will only arise AFTER we’ve come significantly closer to full employment and higher output. Contrary to the analogies we often hear, the government does not face constraints in spending like a household does. The federal government itself neither has nor doesn’t have dollars, any more than a bowling alley ever has a box of points or a football scoreboard has a “hoard” of points that it uses. When the federal government spends, the funds don’t ‘come from’ anywhere any more than the points ‘come from’ somewhere at a football stadium or the bowling alley.
In today’s economy, it is hard to imagine inflation occurring in an environment where almost 20 per cent of our workforce is underemployed. It’s equally hard to imagine how a government which creates its own currency can ever “run out of money”. To go back to our bowling analogy: If you knock down 5 pins at the bowling alley, your score goes from 10 to 15. Do you worry about where the bowling alley got those points? Do you think all bowling alleys should have a ‘reserve of points’ in a ‘lock box’ to make sure you can get the points you have scored? Of course not! But this is exactly the way that government “spends” our money. The government provides computer data entry, much as the bowling alley scoreboard “creates” points.
Government spending should be results-oriented.
Does this mean the government can spend infinite amounts of money? No. The economist Abba Lerner understood that a government’s spending and borrowing should be conducted “with an eye only to the results of these actions on the economy, and not to any established traditional doctrine about what is sound and what is unsound.” In other words, Lerner believed that the very idea of what good fiscal policy means boils down to what results you can get. If we want jobs, then government spending to create them is ‘sound’. Period.
A government should decide what to spend and tax based on a simple idea: getting everybody employed without causing inflation. This does not mean the government can spend all it wants without consequence. If it spends too much, government can ultimately create a lot of inflation, but we have to stop our economy from going further down a hole before we concern ourselves with building up pressures via price increases.
What it does mean is there is no solvency risk. Remember, there is no such thing as our government ‘running out of money to spend’ as President Obama has incorrectly stated repeatedly, and as Krugman wrongly implies in his piece. The only reason we would want the government to spend less is if the private sector desired to spend more (without overwhelming itself in debt again) and/or our exports were surging. Neither of these things are happening today. So there is a need to restore the government contribution to create growth and jobs along the lines that were evident in the full employment period of the 1960s.
Which is clearly something that Paul Krugman wants as well.
It’s time to create a Job Guarantee program.
So let’s create MORE jobs, MORE work hours, and MORE payroll, but let’s do it in a smarter way: a Job Guarantee program. The federal government would ensure a job offer to anyone ready and willing to work, at the established compensation level and including a healthy benefits package. Not only will this provide jobs in the New Deal style program, as Krugman advocates, but it will also save jobs and increase work hours in the rest of the economy. Why go for second or third best when the best option is available, especially since we don’t face the kind of funding constraint that a private business faces?
Having a Job Guarantee program ensures a ready supply of “shovel ready” labor to accommodate economic expansion when government spending finally does its trick and restores significant growth and employment. The pool of government-employed workers is a more “liquid commodity” and more ready to shift back into private sector employment. And because a Job Guarantee program creates a ready source of available “shovel ready” labor to accommodate the expansion, businesses do not have to outbid each other for a smaller pool of skilled labor. The Job Guarantee program expands the pool because it creates MORE employed workers. And as a permanent, rather than temporary feature of government, it will help to sustain a policy which brings us closer to full employment and rising prosperity.
Our current Federal Reserve Chairman, Ben Bernanke, has said that “Under a paper-money system, a determined government can always generate higher spending and hence positive inflation.” But the government also has to know which buttons to press. Lower interest rates are not the buttons for that job. The correct button to push is fiscal expansion, yet Bernanke and other US economists and policy makers such as Krugman appear timid to press this button because of deficit myths. The result is that the continuing shortfall in demand in our economy and resultant high unemployment are entirely self -inflicted.
We are not out of the woods.
Paul Krugman’s concern is legitimate. Unless Obama gets lucky and the fiscal stimulus really begins to catch in early 2010, this is just going to get messier. A politically uglier version of the Japanese lost decade(s) may ensue. Much of the misguided policy at the heart of our current economic debates will come to a head with the deficit terrorists and the hyperinflation hyperventalists ramping up the rhetoric into midterm elections.
Our Nobel Prize-winning economist and his ostensibly progressive allies do us no favors by playing with a script that they appear to believe preserves their credibility, but in fact makes them part of the problem. Doves plead for the fiscal equivalent of St. Augustine’s, “Oh Lord, give me chastity, but do not give it yet.” The deficit terrorists seize on the doves’ notion that “fiscal chastity” is a virtue and ridicule their out-of-paradigm waffling.
This folly leads the likes of Krugman to a real dead end policy-wise, or at least significantly neutralized position. If the doves continue to legitimize the myths that we have “explosive debt trap” or are “running out of money”, they leave the door open to the Palinites and Glenn Becks of this world to determine our fiscal policy. Are theirs the paradigms we want to live with?
Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.
Alot of Cleveland bus drivers were laid off last year. Routes were cut and people have to wait a long time for a bus ride.
I don’t think that keeping bus drivers employed would cause inflation or cost alot. The gov’t could give the bus company RTA a grant in exchange for ‘no layoffs’. It wouldn’t need alot of administration.
Cleveland has such a shortage of police officers that a man was able to kill 11 people and keep the bodies (very stinky) in his house in the city and there was no one from the city with time to look into this.
The Post office is threating layoffs too, they could raise stamp prices or have a similar grant.
I am sure there are many similar cases out there and other programs could be created, but these are so obvious.
Actually The bus company got stimulus money but it cannot be spent on wages, only ‘capital improvements’ ie. stations, new buses. Believe me , in Cleveland you don’t want to wait in a station , you just want the bus to come. Also this president is supposed to be ‘green’ and public transport is important, so he really ‘missed the bus’ on this one.
Posted by alibeamish | December 1st, 2009 at 9:24 pm
It’s past time to get serious about our energy problem(and I don’t mean controlling Middle Eastern oil reserves). This problem could have been the basis for a substantial public works program. Instead, we receive Wall Street bailouts, insufficient fiscal stimulus, and forebodingly, talk of entitlement “reform”. If a recovery does occur, will oil prices race back and eventually surpass the prices from summer 2008? Won’t this trash the economy all over again?
Posted by kevin | December 1st, 2009 at 10:23 pm
Since the government is not bound by the fiscal restraint of raising revenue, ie taxes, would it be possible for the administration to pursue a flat-tax policy to entice conservatives to get on board with a government employment program? I know it is heavily regressive, but if it would result in enough support to get legislation passed to guarantee a job to anyone who wants one, and eventually increase the minimum wage to a living wage, I think it would be worth it.
And it would shut the conservatives up about taxation, for a little bit.
Posted by Zach P | December 1st, 2009 at 10:47 pm
Granted, inflation is not our immediate problem, but your analogy of government’s creation of money to the points on a scoreboard or the number bowling pins is nonsensical to me. Of course the physical ability of the government to create money is virtually unconstrained and we can’t run out of money in that sense. However, unlike points on a scoreboard, money is a medium of exchange that expresses the relative value of goods and services. It doesn’t matter how many absolute dollars are outstanding, but surely matters whether there is a major increase or decrease in the existing stock of dollars. Also, when the government makes its computer entry to create money does it not also incur a liability to pay interest on the bonds it has created? That certainly isn’t the case for bowling pins and scoreboard points. I guess I just don’t quite get your point.
Posted by Bob | December 2nd, 2009 at 12:16 am
Money is simply a unit of account whose value is determined extrinsically. Its primary value under a fiat currency system is to drain demand via the imposition of a tax liability, not to act as a “store of value”. The very fact that the government has this power to create currency unconstrained points to the need to have the power of taxation to rein in incipient inflationary pressures. Government is no more than a scorekeeper. LET’S START BY LOOKING AT what happens should you go to the Federal Reserve to pay YOUR taxes with actual cash.
First, you hand over a pile of currency to the Fed as payment.
Next, the Federal Reserve counts it, and then gives you a receipt and a thank you for helping to pay for social security, the interest on the national debt, and the Iraq war.
THEN, as you, the tax payer, leaveS the room and closeS the door behind you, they take that hard earned cash you just forked over and throw it in a shredder.
Yes, they throw it away. Destroy it! Why?
They have no further use for it. Just like a ticket to the Super Bowl. As you go into the stadium, you hand the man a ticket that was worth maybe $1000, and then he tears it up and throws it away.
So if government throws away your cash after collecting it, how does that cash pay for ANYTHING? Social Security, and the rest of the government’s spending?
It doesn’t. Something else is going on.
Now let’s look at what happens if you pay your taxes by writing a check.
When the government gets your check, and your check IS DEPOSITED AND ‘clears,’ all the government does is change the number in your checking account ‘downward’ when they subtract the payment from your bank balance.
Does the government actually get anything real to give to someone else? No, it’s not like they get a gold coin to spend.
You can actually watch this happen with online banking. You can see the balance in your bank account on your computer screen.
Suppose the balance in your account is $5,000 and you write a check to the govt. for $2,000.
When that checks clears, what happens? The 5 turns into a 3, and your new balance is now down to $3,000. All before your very eyes!
And all they did was change a number in your bank account. The government didn’t actually ‘get’ anything to give to someone else. No gold coin dropped into a bucket at the Fed. All they did was change numbers in bank accounts. Nothing ‘went’ anywhere.
(Can you now see why it makes no sense at all to say the government has to get money by taxing in order to spend?)
To answer your question, Zach, the question is what is the purpose of the tax? It’s clearly not there to raise revenue, but to restrict demand. TAXES CREATE AN ONGOING NEED TO GET DOLLARS and therefore an ongoing need for people to work to get dollars.
And guess who does all this in the first place to get people to work for it and sell it the goods and services it needs?
Right, the federal government!
Just like the coupon tax on the children creates an ongoing need for them to need coupons and do chores for the parents to get them.
Think of a property tax. You have to pay this tax or lose your house. So now you are motivated to sell things - goods, services, your own labor - to get the dollars you need to pay the tax.
In terms of your question on whether a flat tax would work, that’s not really the way I look at it. The question is that for a given amount of government spending, which we presume is necessary to run the country the way we’d like to see it run, how high should taxes be? The answer is:
Taxes should be at the right level so that we all have enough spending power left to buy what’s still for sale in the store after the government is done with its shopping.
Posted by Marshall Auerback | December 2nd, 2009 at 1:20 am
I think Krugman’s “small” suggestions have to do more with the current political climate than abstract theory. It’s true, the government could employ every unemployed American directly at a liveable wage - and wouldn’t that be nice? - but can you see the Obama administration convincing Congress to do that?
Bear in mind, I’d love it if Obama would go in whole hog with a real New New Deal, including a new energy grid, new mass transit systems, better schools, and a full employment policy, but even if he does secretly desire this programme (doubtful), he still has Congress to deal with.
Posted by James Call | December 2nd, 2009 at 7:19 am
On a more positive note, your descriptions of fiat currency are beginning to make more sense to me (a civilian)
Very much appreciate your passion and dedication in this regard.
Posted by James Call | December 2nd, 2009 at 7:20 am
You might be correct, James, but my point is that if we construct policy solely on the basis of what is “politically possible”, then we get suboptimal results. Look at health care. Maybe we can’t get single payer, but if you concede that from the start, you end up with a horribly eviscerated public option (which still might not be in the final health care bill).
And for those progressives- (the deficit-doves) –who present their arguments in a conservative way because the public might not understand the finer points of economic theory, or because what they are suggesting is not “politically possible”, Abba Lerner had this to say:
The scholars who understand it hesitate to speak out boldly for fear that the people will not understand. The people, who understand it quite easily, also fear to speak out while they wait for the scholars to speak out first. The difference between our present situation and that of the story is that it is not an emperor but the people who are periodically made to go naked and hungry and insecure and discontented – a ready prey to less timid organizers of discontent for the destruction of civilization (“The Economics of Employment”, 1951)
Posted by Marshall Auerback | December 2nd, 2009 at 2:34 pm
Well put. Still, Krugman did initially call for a >$2 trillion stimulus, and of course, such suggestions were scoffed at by the Obama administration econ team. So I think at this point he’s just sort of praying for something, anything. Certainly, if Obama were to make a bolder set of demands, the politics of the situation would shift in favor of a progressive viewpoint. But will he? Is such thinking his conviction?
Posted by James Call | December 2nd, 2009 at 4:52 pm
Taxes as a means of constricting demand? Maybe I don’t understand what you’re trying to say. But at least it emboldens me to make the following couple of points.
There is a debt problem. It is the household and business debt that is threatening to generate a debt deflation of the Great Depression model. It is this debt that needs to be reduced, and the creditors that need to do the reducing. Private debt to GDP is almost twice that which caused the Depression.
One of the reasons to produce jobs for people is to counteract this deflation. The great furor around the Fed’s attempts to produce money is much ado about nothing. The Fed has produced it, but it sits idle in bank reserves, just as Minsky said it would.
The Fed is doing everything it can to produce a less valuable dollar in hopes of generating inflation and thus helping people float out of their debt service chains. It is not working. Everybody said “recapitalize the banks” because the banks can then lend seven, eight, nine times and the money goes further.
Didn’t happen. Will not happen. All that help to the banks is just sitting there on their balance sheets. It’s time to get some help to workers and household debtors.
The foofaraw around the federal debt makes about as much sense as that around the supposed inflation on the horizon. It is the private and business debt we ought to be worrying about.
Posted by Alan Harvey | December 3rd, 2009 at 12:23 am
I’d like to know more about the notion of taxes as a means of restricting demand. Does anyone in government talk about it this way? Is is a secret? Or a result of a lack of understanding of the way money functions? Thank you to Mr. Auerback for attempting to get these arcane theories understood by the public. We all need a financial education.
Posted by Nellie | December 3rd, 2009 at 1:11 pm
No, very few people view taxes in this manner. They view taxes a something that the government needs to “fund” our programs. But that’s the incorrect causality. Government first “spends” by crediting bank accounts, and thereby bringing into the economy the currency which is then used and spent. As the government is in a unique position of being able to “muscle” its way into the economy by virtue of being the monopoly supplier of currency, it can also create inflation if it spends too much. Consequently, it needs an instrument to drain demand. The tax achieves this, as it reduces your spending power (and mine). If the government were to increase your taxes, you’d have less spending power and this would ultimately decrease your ability to spend and thereby reduce demand (unless the government were to spend more). If the govt. doesn’t tax because it needs the money to spend, why tax at all?
Answer: The govt taxes to regulate what economists call ‘aggregate demand’ which is a fancy word for ‘spending power’ In short, that means that if the economy is ‘too hot’ raising taxes will cool it down, and if it’s ‘too cold’ cutting taxes will warm it up. Taxes aren’t about getting money to spend, they are about regulating our spending power to make sure we don’t have too much and cause inflation, or too little which causes unemployment and recessions.
So why does no one in government seem to get it? Why does the Ways and Means Committee in Congress worry about ‘how are we going to pay for it’?
One reason might be because they are stuck in the popular notion that the government, just like any household, must somehow first ‘get’ money to be able to spend it.
Yes, they have heard that it’s different for a government, but they don’t believe it, and there’s never a convincing explanation that makes sense to them.
What they all miss is the difference between spending your own currency that only you create, and spending a currency someone else creates.
Posted by Marshall Auerback | December 3rd, 2009 at 5:36 pm
So do you think cutting taxes in the current environment would create inflation? I find that difficult to believe.
And the big tax cuts under Bush needed 1% interest to get any heat out of the economy.
I can see that specific taxes, like on gasoline or cigarettes might restrict demand for that item.
Is there a particular period of history that bears this out? It seems to me taxes are just cycled back through the system, by federal or state demand or the demand from social security recipients.
Posted by Alan Harvey | December 3rd, 2009 at 11:39 pm
Would cutting taxes in the current environment create inflation? Not right now, no. But if the government continued to spend or cut taxes, eventually, that would significantly increase the purchasing power of individuals and you probably would go some way toward narrowing output gaps and increasing employment, at which point the tax cuts could be inflationary. But by the time you reached that point, you could reduce spending or increase taxes. The automatic stabilisers working in reverse would also reduce some of that aggregate demand.
Is there a particular period of history that bears this out? A number of pieces and books, including L. Randall Wray’s “Understanding Modern Money”. But you might consider starting with this one, Alan.
http://www.cfeps.org/pubs/wp/wp35.html
Posted by Marshall Auerback | December 4th, 2009 at 6:17 am
er, I think Mr. Harvey was inquiring about a specific tax cut or era of tax cutting that created inflationary pressures. Right?
Posted by James Call | December 4th, 2009 at 10:58 am
James is right. And while your point is probably true, that “evenutally” is not likely to be in this world, absent complete desperation. But more to my point, it doesn’t seem that inflation and taxation have an inevitable connection. Likewise, even the Fed’s interest rate (which is overtly used to dampen inflation) doesn’t seem to work very well. It seems to be more effective in stalling the economy and less effective in getting it going again.
I did check out the the link. I remain unconvinced (though not completely comprehending).
I agree that the current theory is not working. The Fed’s and really the rest of the economic mainstream’s idea that the money multiplier and increasing base money would produce multiples as the banks lent it out failed most brilliantly with the recapitalization of the banks after TARP. I am more inclined to the explanation of the post-Keynesians as relayed by Steve Keen here:
http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/
of a circuit theory.
Clearly, as Keen says somewhere in all those words, the fact that credit creation precedes rather than follows Fed action means the theory we were all schooled in has long been known to be false. (and from the research of none so conservative as Edward Prescott).
Posted by Alan Harvey | December 5th, 2009 at 2:38 pm
“Clearly, as Keen says somewhere in all those words, the fact that credit creation precedes rather than follows Fed action means the theory we were all schooled in has long been known to be false. (and from the research of none so conservative as Edward Prescott).”
Yes, but doesn’t it stand to reason that if credit -destruction- is occurring, only the Fed has the power to reverse this process? I may have misunderstood your link, but that would seem to be the case.
Posted by James Call | December 5th, 2009 at 6:28 pm