Streetwise Professor

November 5, 2009

Paul Krugman: Poster Child

Filed under: Economics,Financial crisis,Politics — The Professor @ 12:13 pm

For my adage: the greatest lesson of the Great Depression is that we learned the wrong lessons about the Great Depression.   Krugman’s (wrong) lesson?:

It took the giant public works project known as World War II — a project that finally silenced the penny pinchers — to bring the Depression to an end.

The lesson from FDR’s limited success on the employment front, then, is that you have to be really bold in your job-creation plans. Basically, businesses and consumers are cutting way back on spending, leaving the economy with a huge shortfall in demand, which will lead to a huge fall in employment — unless you stop it. To stop it, however, you have to spend enough to fill the hole left by the private sector’s retrenchment.

Beyond the creepiness of confusing mass destruction with creation, Krugman’s analysis is inane, not to say insane.   It highlights the dangers of obsessing on a single data point, and using a single episode to draw broad (and arguably universal) conclusions.   Put differently, the monomaniacal focus on the Great Depression blinds Krugman to the obvious reality that it is the exception rather than the rule.   By ignoring its exceptional nature, Krugman goes seriously astray.

Both its severity and its duration make the Great Depression exceptional.   Market economies had endured other downturns before, some (like the one of 1920-1921) nearly as severe at the outset as the 1930-1940 depression.   But in these earlier episodes, after a period of months or years, economic activity rebounded, usually without any massive fiscal intervention.   Similarly, post-War recessions did not endure for extended periods.

The temporary nature of previous (and subsequent) declines casts doubt on the kinds of Old School Keynesian (“OSK”) (not even neo-Keynesian) stories that Krugman is trying to tell.   In particular, it casts doubt on the reality of an autonomous collapse in “aggregate” demand (driven by animal spirits) that can last indefinitely, absent some external, fiscal demand stimulus to offset it, and which is immune to monetary policy.     That is, these OSK musings are explanations crafted to explain a single data point, but they don’t hold up in broader samples.

Which should raise the question: Why was the Depression exceptional?   It couldn’t be the lack of fiscal stimulus–which had been lacking in, say, 1920-1921 too, and in other episodes as well.   Relatedly: Could policy errors (e.g., interference in the price system that impeded adjustment to shocks, bad monetary policy) have made this particular depression a Great one?

By advocating a massive additional stimulus today based on his reading of the “lessons” of the Great Depression, Krugman also implicitly assumes that the conditions that contributed to the Great Depression’s severity are present today.   Even if one believes that the Great Depression was a Keynesian event that required a massive fiscal stimulus to end, that doesn’t imply that the current recession (severe by post-War standards, but mild compared to the Big One) is a Keynesian one as well.   Moreover, differences between the structure of the world economies then and now are so great, and the precipitating events are so different, that it is extremely dangerous to argue by analogy.

I’ve written before that it is my impression that business cycle theorists of all stripes have made the intellectual error presuming that all cycles are alike.   (EG., my recollection of Lucas’s macro course in which he said that a review of Mitchell’s work on quantifying business cycles had convinced him that they were so similar that they likely had a common cause).   Before swallowing Krugman’s recommendations for A Stimulus on Meth, it would be advisable to ask: (a) Is Krugman’s analysis of the Great Depression correct?, and (b) Is the analogy between the Great Depression and current circumstances an apt one?

The answers to both questions are most likely “no.”   The validity of the Old School Keynesian theory of depressions is dubious enough for the Great Depression, and its general applicability even more so.     Given these serious doubts, we would be fools indeed to embrace Krugman’s nostrums.

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  1. Bob Higgs has written extensively on this, exploding the myth that WWII got us out of the Depression. E.g.:

    Comment by Peter G. Klein — November 5, 2009 @ 1:55 pm

  2. Amen. Krugman is over the top, even for regular OSK’s who would argue that it was the PWA, NRA, TVA, and other TLA’s that set up the return.

    The notion that WWII ended the depression is just Bastiat’s broken window story writ large: “Let’s destroy a bunch of stuff and kill a lot of people so that it will stimulate demand.” I’ve heard it many times, and it sounds as dumb now as the first time.

    Comment by Hal — November 5, 2009 @ 2:37 pm

  3. What about *all* windows breaking in *another* country, and they have neither enough glass, nor glaziers?

    Comment by So? — November 5, 2009 @ 9:33 pm

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