Paul Krugman, the Doctor, Concedes the Existence of Retrenchment


While making the case for more stimulus, New York Times columnist, Nobel Prize-winning economist and odds-on People's Choice Award favorite Paul Krugman makes an interesting reference to the possibility of ongoing economic shrinkage. Krugman criticizes business forecasters who favored an $800 billion stimulus in January but don't support a new package of spending now. In economist-speak, Krugman says, you need to weight the marginal benefit of stimulus — that it "adds employment and output" — against the marginal cost:

The marginal cost is the way stimulus adds to debt. This cost gradually rise as you add more debt, since the risk of an eventual crisis is increased. But does anyone really think that, say, another $500 billion in borrowing would be the straw that breaks the camel's back?

The point is that it's very hard to imagine what would lead you to say that $800 billion in stimulus, which leaves the economy deeply depressed, is just right. You could make a case that no stimulus at all—in fact, fiscal retrenchment—is appropriate. Or you could, like me, call for substantially more. But ratifying what we've done, and no more, makes very little sense,

(Boldface mine.) By adding "output," I presume Krugman is thinking of the growth in U.S. GDP during the 1930s, which he believes the government squandered by calling off its stimulus too soon. He may also have a theoretical model in which government spending can increase output, though that theory faces a pretty steep horse-sense hurdle.

You can also make the argument that government spending can create jobs, at least of the proverbial digging-and-filling-holes variety. But the idea that government spending can lead to a net increase in employment (unless you count conscripted and very low paid employment) seems like a stretch.

What's notable is that Krugman says there is a (presumably legitimate) case that "fiscal retrenchment" is appropriate. That's a welcome concession, but the point isn't that economic retrenchment is appropriate. It's that economic retrenchment is happening, and will continue to happen no matter what the government (which went into this crisis with a vastly larger debt than it had in the 1930s) does.

It's hard to find any index that doesn't suggest more deflation is coming. Residential real estate is still cliff-diving. Commercial real estate has just begun its decline and will face important structural changes whenever it rebounds (i.e., more of what we used to call "brick and mortar" retailers will have been replaced by the interwebs). America's new favorite economic indicator, the rail freight index, is pulling a Casey Jones. And the deleveraging of the American citizen is happening almost as fast as the releveraging of the American government. So where are the inflationary pressures? (U.S. worker productivity remains high, but even productivity growth has been hit and miss since the start of the recession; there could actually be more room for wages to fall.) America just isn't worth as much as we want it to be worth.

I guess Krugman could argue that this is happening because evil economic non-interventionists think it's appropriate. But to me it looks like it's happening because reality thinks it's appropriate.