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Published On: Thu, May 24th, 2012

Will inflation save Europe?

In a recent column, Paul Krugman says that Europe essentially is committing “economic suicide” with its various “austerity” programs, with the only thing that can save the Continent being inflation. While I can agree with him in part that “austerity” programs as outlined by the European Central Bank can be harmful to economic growth, the idea that inflation is the magic elixir that turns bad economies into engines of prosperity is pure snake oil.

Krugman writes:

So if European leaders really wanted to save the euro they would be looking for an alternative course. And the shape of such an alternative is actually fairly clear. The Continent needs more expansionary monetary policies, in the form of a willingness — an announced willingness — on the part of the European Central Bank to accept somewhat higher inflation; it needs more expansionary fiscal policies, in the form of budgets in Germany that offset austerity in Spain and other troubled nations around the Continent’s periphery, rather than reinforcing it. Even with such policies, the peripheral nations would face years of hard times. But at least there would be some hope of recovery. (Emphasis mine)

How much inflation? Krugman does not say, although he should know that once a government goes down the inflation path, it needs to apply increasing amounts of inflation over time to get the same effects. The history of inflationary episodes is quite clear on that point.

However, at the same time, we have to understand just what is meant by “austerity” in the European sense. The ECB (with the Federal Reserve System lurking in the background) has engineered a bailout of the banks that lent these governments lots of euros, and in order to now pay back the loans, the governments must cut spending and raise taxes.

Cutting spending, contra Krugman, is not necessarily contractionary, although European governments impose heavy costs upon business, making it harder for businesses to be an engine for recovery. Krugman mentions Spain and its near-24 percent unemployment. What he does not say is that Spain has some of the most restrictive employment regulations in the world in which employees, once hired, pretty much have something akin to tenure, which means employees pretty much cannot be fired for any reason.

Under that set of incentives, when businesses find the back door nailed shut, it means that the front door is much harder to open. Unfortunately, people like Krugman cannot see such policies as having any effect upon employment rates in Spain because they tend to see government employment as morally and financially superior to private employment, so that if Spain makes it difficult for businesses to hire people, then let government “pick up the slack.”

There is an underlying issue that Krugman cannot see because of his anti-enterprise ideology. For many years, Europeans have looked down their noses at the USA because it has not had the same restrictions on businesses as Europe and the USA’s welfare state is not as vast as that on the Continent.

Yet, such restrictions and heavy spending have made it more difficult for businesses to generate real wealth, which ultimately has translated into slow growth and high unemployment. Unfortunately, the current spate of “austerity” programs fails to recognize how new wealth can be created and what it really would take for Europe’s economies to grow.

Krugman, however, would have none of that. His message to Europe is simple: keep the restrictions on business in place, increase government spending, and print money, lots of money. Such actions in the present might mask the underlying problems, but in the long run, it would be disastrous.

But to Keynesians such as Krugman, it doesn’t matter. In the long run, all of us are dead.

Check out the “Krugman in Wonderland” posts here on DOB – click here


William L. Anderson is an author and an associate professor of economics at Frostburg State University in Maryland. He is also an adjunct scholar with the Mackinac Center for Public Policy as well as for the Ludwig von Mises Institute in Alabama.

Read more at “Krugman-in-Wonderland”

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About the Author

- William L. Anderson is an author and an associate professor of economics at Frostburg State University in Maryland. He is also an adjunct scholar with the Mackinac Center for Public Policy as well as for the Ludwig von Mises Institute in Alabama.

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