It is not often that I agree with the the way Paul Krugman envisions the world, at least superficially — or through the lens of politics. However, once in a while (whether intended or not), he allows the old, economist Paul Krugman to shine through, and writes something that I agree whole-heartedly with. Today, he did just that. And it always makes me feel accomplished to agree with Paul Krugman!
Anyway, in today’s NYT op-ed, Krugman implicates tight money as the main problem facing Greece (and, de facto, the rest of the EMU):
Yes, Greece is paying the price for past fiscal irresponsibility. Yet that’s by no means the whole story. The Greek tragedy also illustrates the extreme danger posed by a deflationary monetary policy. And that’s a lesson one hopes American policy makers will take to heart.
It’s a really odd situation Krugman has found himself in throughout this recession. On one hand, he’s a giant in macroeconomics, who sometimes recognizes that liquidity traps aren’t ever actually binding…and on the other hand has to continually make up rationale for his advocacy of fiscal policy based upon vintage Keynesianism. However, it’s hard to hide the fact that tight money is a major problem in the Eurozone, and will continue to be for quite some time it would seem.
This is a not a good situation, as European growth levels are already low, a lower NGDP trajectory going forward from the recession — combined with Europe’s lower productivity level, sets the stage for a lot of other problems down the road. And not just in Greece, but every other member of the EMU. You may think this would be a time to score a rhetorical “point”, but alas, it is not. The people of Europe are seem very easily excitable, and the backlash caused by low growth and stagnant productivity could spell a more forceful call for socialist reforms, reversing the trend toward markets that the EU has been fostering even more formidably than the “free market” US. Not only that, but trade is a positive sum game — it is in everyone’s best interest that everyone else does well going forward.
Secondly, Krugman schools those who have a fairly myopic view of public debt:
So how did the U.S. government manage to pay off its wartime debt? Actually, it didn’t. At the end of 1946, the federal government owed $271 billion; by the end of 1956 that figure had risen slightly, to $274 billion. The ratio of debt to G.D.P. fell not because debt went down, but because G.D.P. went up, roughly doubling in dollar terms over the course of a decade. The rise in G.D.P. in dollar terms was almost equally the result of economic growth and inflation, with both real G.D.P. and the overall level of prices rising about 40 percent from 1946 to 1956.
I’m always trying to explain to people how public debt works, and the overarching point that I try to instill in people is that; while debt may matter, it is growth levels that matter much more. I’m not sure off the top of my head what the trend growth rate for the Greek economy has been, or what their productivity levels look like — but if they track the EU, then I’d be skeptical that Greece can grow its way out from under its debt burden, especially given the grinding deflation that it will likely need to endure.
Third, I’m a Euroskeptic…so any news of the Euro’s implementation not following the tenets laid out in macroeconomic theory plays to my bias, and I might as well mention that Krugman serves up some:
Until recently, being a member of the euro zone seemed like a good thing for Greece, bringing with it cheap loans and large inflows of capital. But those capital inflows also led to inflation — and when the music stopped, Greece found itself with costs and prices way out of line with Europe’s big economies.
This is exactly at odds with the “law” of one price. The theory suggests price convergence in the absence of transaction costs — the EU and EMU was created to reduce transaction costs…and the standard deviation in prices should have fallen. Not so in Greece, nor many other countries in the Eurozone (though not surprising, the ECB is overrepresented by the interests of Frankfurt and Brussels).
To conclude, here is Krugman’s worries, which I share to some extent:
What worries me most about the U.S. situation right now is the rising clamor from inflation hawks, who want the Fed to raise rates (and the federal government to pull back from stimulus) even though employment has barely started to recover. If they get their way, they’ll perpetuate mass unemployment. But that’s not all. America’s public debt will be manageable if we eventually return to vigorous growth and moderate inflation. But if the tight-money people prevail, that won’t happen — and all bets will be off.
No doubt Krugman is referring to Kansas City Fed President Thomas Hoenig. It seems to me that Krugman buys in to Oliver Blanchard’s call for a higher inflation target. I’ll get of the train there, please.