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Deflationary spirals and low-balling Krugman

February 17th, 2009 · 1 Comment

Funny to see how nobody can deal with the arguments of Paul Krugman, who argues the government is the only party in the economy who can spend enough to prevent a deflationary spiral from which it is very hard to escape. Here is one attempt, but the writer, a businessman and investor, has to create his own economics in order to succeed..

That businessman is a certain Francis Cianfrocca, and here is his article:

In it, he argues that:

  • Yes, there is a shortfall of demand of $2.9 Trillion over three years
  • Yes economics has it that every dollar spend by the government creates one-and-a half times as much in GDP (in economic terms: the multiplier is about 1.5), so the spending needed to fill the output gap is a stimulus program of $1.3 trillion over two years

The logic is compelling, but not to Mr. Cianfrocca:

  • The President faces a different trap. By believing the mathematics and not the people, he’s come out in favor of a huge spending plan that runs deeply counter to what nearly every American now feels deep in her marrow: that this is a time for saving, not for borrowing and spending.
  • And there’s something very important about this that even an economist needs to account for. Because the overall mood of the country prohibits a quick return to spending and investment, the multiplier effect of the stimulus will be muted. It will perform far below expectation. On top of that, its effects will not stimulate the economy in any permanent way, but will rather dissipate as soon as the stimulus does.

Basically, Mr. Cianfrocca has invented a new kind of economics. We would advise him to publish a scientific paper as soon as possible. If he’s right, it will make him famous. But does he actually have any evidence?

In the article itself he basically wants us to assume his observations are self-evident. And indeed, people need to restore their balance sheets, which is why they are inclined to save.

Which is exactly why we need the government to spend. They are the only party that can spend without succumbing to fear. If they give tax cuts, at least part of it will be saved.

And government spending will create extra income, which will also at least in part be spend (which is exactly how that multiplier effect works).

Another curious argument from Mr. Cianfrocca:

  • And why won’t it simply recover on its own, as it has many times in the past?

Well, this is exactly what a deflationary spiral makes so difficult. This is what happens: people can restore their balance sheets by selling assets and saving more. But everybody selling assets just further depreciates their value, leading to more selling, and more saving (which reduces spending, worsening the economy, further depreciating asset prices and increasing unemployment, further deceasing spending, etc. etc.).

You get the picture. This is exactly what we’re facing, why it’s unlikely the economy will not recover by itself any time soon, and why it’s so paramount that at least somebody should spend. The only one can be the government.

Another cheap shot at Krugman from Mr. Cianfrocca:

  • Let’s note that Krugman is a sober, first-rate economist, but also a woolly-eyed, low-grade political hack. He firmly believes that government is better qualified than private actors to direct the country’s economy, and has advocated a Federal government share of 28% of GDP, compared to the current 22% or so.

We have read most of what Krugman wrote since the 1980s, if Mr. Cianfrocca can come up with anything that suggest that Krugman beliefs that government is better qualified than private actors to direct the country’s economy, will be curious.

And calling someone a woolly-eyed, low-grade political hack is exactly the kind of thing one would call someone when one cannot deal with his arguments…

Tags: Credit Crisis · Public Policy

1 response so far ↓

  • 1 ron cobb // Feb 20, 2009 at 5:34 am

    You win…Krugman is the 21st century”s brightest guy. He is irrefutable. Long live big government. But thanks for exposing other views.