The Fairy Tale of Our Time, ‘massive consumer spending is what fuels an economy’

Paul Krugman is nothing if not consistent. Once again, we are told that Kenneth Rogoff is the main reason that our economy is not roaring along like boom times, and that massive consumer spending is what fuels an economy, and that by employing the Debt Fairy and the Inflation Fairy, or, more specifically, putting them on steroids, we can lick this thing and have yet another boom.

Writes Krugman:

Families earn what they can, and spend as much as they think prudent; spending and earning opportunities are two different things. In the economy as a whole, however, income and spending are interdependent: my spending is your income, and your spending is my income. If both of us slash spending at the same time, both of our incomes will fall too.

And that’s what happened after the financial crisis of 2008. Many people suddenly cut spending, either because they chose to or because their creditors forced them to; meanwhile, not many people were able or willing to spend more. The result was a plunge in incomes that also caused a plunge in employment, creating the depression that persists to this day.

Why did spending plunge? Mainly because of a burst housing bubble and an overhang of private-sector debt — but if you ask me, people talk too much about what went wrong during the boom years and not enough about what we should be doing now. For no matter how lurid the excesses of the past, there’s no good reason that we should pay for them with year after year of mass unemployment.

Thus, the Twin Fairies should make their grand entrance:

So what could we do to reduce unemployment? The answer is, this is a time for above-normal government spending, to sustain the economy until the private sector is willing to spend again. The crucial point is that under current conditions, the government is not, repeat not, in competition with the private sector. Government spending doesn’t divert resources away from private uses; it puts unemployed resources to work. Government borrowing doesn’t crowd out private investment; it mobilizes funds that would otherwise go unused.

Now, just to be clear, this is not a case for more government spending and larger budget deficits under all circumstances — and the claim that people like me always want bigger deficits is just false. For the economy isn’t always like this — in fact, situations like the one we’re in are fairly rare. By all means let’s try to reduce deficits and bring down government indebtedness once normal conditions return and the economy is no longer depressed. But right now we’re still dealing with the aftermath of a once-in-three-generations financial crisis. This is no time for austerity.

Paul Krugman caricature cartoon


(I can envision the debate in the halls of government around the world in which politicians declare their utter fealty to Ken Rogoff and tremble in fear at the prospect of violating his “90 percent” Rule. Yes, politicians that invariably benefit from spending schemes meant to gain votes are going to tremble in fear lest they disturb The Rogoff.)

Understand that Krugman defines “austerity” as anything short of a massive increase in government spending, with debt and inflation leading the charge, since the economy is not producing enough in order to pay for this spending with taxes. Whatever increases in spending that have come from the Obama administration, they are not enough, not nearly enough.

In Krugman’s view, money coming from the sources of borrowing and creating new money is a near-perfect substitute for real wealth, asmoney borrowed at low interest rates essentially is “free” money and more spending will bring about more capital investment, although Krugman has made it clear elsewhere that capital investment is pretty much irrelevant in the scheme of things, except for the spending that comes with that investment.

Krugman also seems to believe that money borrowed essentially for consumption purposes really is no different than money borrowed for private capital investment. (J.M. Keynes in The General Theorysurmised that changes in investment spending were what caused ups and downs of the business cycle, and those changes centered around the “animal spirits” of investors.) In the end, it is the spending and only the spending that matters.

Furthermore, as Krugman wrote last week, the real villains behind supposed austerity are the wealthy “one percent” who benefit from others being out of work. He continues today with that theme:

Is the story really that simple, and would it really be that easy to end the scourge of unemployment? Yes — but powerful people don’t want to believe it. Some of them have a visceral sense that suffering is good, that we must pay a price for past sins (even if the sinners then and the sufferers now are very different groups of people). Some of them see the crisis as an opportunity to dismantle the social safety net.

There really is no way to bridge the intellectual gap between Austrians and Keynesians. In the Keynesian view, the “social safety net,” massive subsidies for “green energy,” and other instances of government spending are the economic equals of private investment. Perhaps Obama said it best when he announced he was delaying action on the Keystone Pipeline and declared that an increase in unemployment benefits actually would be economically superior to investment in an oil pipeline, since new benefits (which would be financed by new borrowing) would fuel immediate consumer spending, as opposed to the spending that would accompany creation of Keystone.

(This is not an endorsement of the pipeline itself. Instead, I am demonstrating how Keynesians and fellow travelers like Obama see an entire economy in terms of nothing but current spending.)

In contrast to the Keynesian position, Bill McNabb of the Vanguard Group writes that what Robert Higgs has called “regime uncertainty” is behind the dearth of private capital investment:

Companies and small businesses are also dealing with the same paradox. Many are in good shape and have money to spend. So why aren’t they pumping more capital back into the economy, creating jobs and fueling the country’s economic engine?

Quite simply, if firms can’t see a clear road to economic recovery ahead, they’re not going to hire and they’re not going to spend. It’s what economists call a “deadweight loss”—loss caused by inefficiency.

Today, there is uncertainty about regulatory policy, uncertainty about monetary policy, uncertainty about foreign policy and, most significantly, uncertainty about U.S. fiscal policy and the national debt. Until a sensible plan is created to address the debt, America will not fulfill its economic potential.

Yes, Krugman derides such thinking as the “Confidence Fairy,” but Krugman and the Keynesians want us to believe that as long as government borrows and spends, business investors are going to ignore the heated anti-enterprise rhetoric from the administration, and are not going to be affected at all by hostile regulators from the EPA and Department of Labor, and the new burdens of ObamaCare, not to mention all of the new taxes that Obama is demanding as part of any budget deal. Keynesians can speak all they want about businesses simply waiting for people to spend, but if they believe that the president wants to impose new policies that will negate any future profits, they are not going to invest at all.

As I see it, the biggest fairy tale of all is that government can bring back prosperity by borrowing, printing and spending and substituting Crony Capitalism for the real thing. There is a reason this economy wallows in depression, and empowering the Twin Fairies and a president who believes private enterprise is evil will magically turn around our fortunes. It is more likely that a poor maid can spin straw into gold.

Krugman in Wonderland 624

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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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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