Saturday, April 2, 2011

Krugman Claims Fiscal Expansion Not the Right Response to Most Recessions

I am really getting dizzy with Paul Krugman's view of the economic world. I always thought that he held the view that all recessions were caused by a lack of aggregate demand, which could be solved by more government spending. Apparently, not.  As Krugman tells us today, fiscal expansion is an "unorthodox policy". I am not making this up, in a post where he attacks Bob Murphy (I'll let Murphy defend himself on that part of the post), Krugman also writes:
I know that some people find this hard to understand — perhaps because they don’t want to understand — but people like me have never claimed that fiscal expansion is always and everywhere the right policy, even in response to recession. Nor are other arguments, like the argument that falling wages reduce, not increase, unemployment, universal. All of the unorthodox policy recommendations and conclusions are contingent on the economy being in a liquidity trap, in which short-run nominal interest rates are up against the zero lower bound and can’t go lower.
And liquidity-trap conditions are rare; in fact, they’ve only happened twice in US history. Unfortunately, we’re living in one of those episodes right now.
I haven't read all of Krugman's work, so perhaps this is a consistent view of his. But, most Keynesians, I would think, if you polled them, would say they hold the view that expansionary fiscal policy is called for to solve all recessions. There are many interpretations of Keynes out there but it is nice to know that Krugman puts himself in the tight Keynesian box that considers fiscal expansion an "unorthodox policy" that should be used under very limited circumstances.  It seems that the only other time Krugman thinks fiscal policy should have been used is during the Great Depression.

I think I will file this quote for reference during future recessions to contrast against any Krugman policy recommendations he might give at that time.

As for Krugman's actual claim that the economy is in a liquidity trap, "in which short-run nominal interest rates are up against the zero lower bound and can’t go lower," this is simply wrong, I have discussed the topic in detail before.

(Special shout out to Murphy with whom I discussed over the Bat phone Krugman's Keynesian view.)


  1. Yeah I was going to pounce on that too, but then I caught myself. I think Krugman possibly *was* against "fiscal expansion" during the Bush years, in the sense that he thought they should raise taxes and not spend so much invading Iraq.

    But in general I like your take on this, Wenzel. Is Krugman really saying that the only two times in US history when deficit spending was a good idea, were the 1930s and post-2007? If this is Keynesianism...well no, don't call me a Keynesian, but you get my point.

  2. they say "liquidity trap" I say "asset value trap" say tomato I say tomaahto...let's call the whole thing off


  3. Liquidity trap: That short period when people are no longer so stupid that they will borrow more funny money due to impending deflation as prices seek reality.

  4. Bob,

    The predicament is that the Keynesians are stuck in a credibility trap. The world in reality is like a multi-colored painting, whereas they view it like black and white. Liquidity trap is both a good thing and a bad thing and it really depends on the situation which lead to the trap. The housing bubble has led us to this trap and this is a good thing. Deleveraging has to happen, but the banks have over-borrowed and the government is on the side of the borrowing banks rather than the scrupulous savers.

  5. I don't care what Paul Krugman says. He's a moron.