Paul Krugman misrepresents what free-market economists believe

I probably made a mistake in reading Krugman's latest NY Times column.

It’s also worth pointing out that everything the right said about why Obamanomics would fail was wrong. For two years we’ve been warned that government borrowing would send interest rates sky-high; in fact, rates have fluctuated with optimism or pessimism about recovery, but stayed consistently low by historical standards.

Free-market economists haven't been arguing this. Free-market economists realize that we live in a world capital market. While the US government borrowing might be a significant portion of the US capital market, it is very tiny compared to the entire world's capital market. For economists, there is also the discussion about Ricardian equivalence, the notion that people anticipate that higher deficits today mean higher taxes tomorrow. Even in a closed economy, the savings from that threat of higher will offset the increased borrowing. The first point about the size of the market is obviously true.

For two years we’ve been warned that inflation, even hyperinflation, was just around the corner; instead, disinflation has continued, with core inflation — which excludes volatile food and energy prices — now at a half-century low.

There has not been deflation. Over the last year, inflation has been at about 2 percent. The notion of core inflation is simply silly. Even if the money supply was constant and the velocity of money unchanged, some prices would go up and some would go down. The only way you can determine if there is inflation is by looking at all prices in the aggregate. As to why inflation hasn't gone up with the increase in the money supply, M1, some free-market types have discussed this. There is no reason to expect Krugman to actually respond to these claims.

The free-market fundamentalists have been as wrong about events abroad as they have about events in America — and suffered equally few consequences. “Ireland,” declared George Osborne in 2006, “stands as a shining example of the art of the possible in long-term economic policymaking.”

Apparently, it is difficult for Krugman to realize that more than one factor is changing at a time. On the one hand, lower corporate income taxes made Ireland an attractive place to invest. On the other hand, the Irish government guaranteeing its banks against default in the fall of 2008 caused them to take riskier positions than they otherwise would have taken. The US government also played a significant role in creating bank problems around the world by Fannie and Freddie mislabeling the housing mortgages that they bundled together.

Right now Mr. Obama is hailing the tax-cut deal as a boost to the economy — but Republicans are already talking about spending cuts that would offset any positive effects from the deal.

How about this discussion: "The problem with this multiplier claim is pretty simple. First, the money has to come from some place.
Second, everyone spends their money one way or another. This claim of some people "spending" their money while others are "saving" it really assumes that saving is the equivalent of burying one's money in a hole in the backyard. In reality, if you don't spend your money, you are putting it in the bank or you are putting it in stocks or bonds, which means you are giving it to someone else to spend. . . ."

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Blogger LB said...

I only took one-two Econ class so I definitely don't think that I know more about it than you do.

You keep making this claim without supporting it. "In reality, if you don't spend your money, you are putting it in the bank or you are putting it in stocks or bonds, which means you are giving it to someone else to spend. . . ."

Right now, you have to supply evidence that banks are actually lending money in a away that offsets spending by the govt, correct? From what I can find, banks aren't lending money right now which means that it is sitting somewhere. If that's the case, govt spending would be taking its place in the market.


That Ricardo's theory seem rather dubious. I located this passage, "The major arguments against Ricardo's theory are due to the unrealistic assumptions on which the theory is based, such as the assumptions of the existence of perfect capital markets, the ability for individuals to borrow and save whenever they want, and the assumption that individuals will be willing to save for a future tax increase even though they may not see it in their lifetimes."

I definitely don't have an ability to borrow and save when I want to and if the tax is going to come after I'm gone why would I change my spending habits today?

Hum, I'm missing your point about the Irish. I understand that the govt stepped in and backed the banks but the banks were having issues already, a funding shortage. The govt didn't have anything to do with that, right? The article says that housing colapsed. If anything, it seems like they should have failed earlier.

This article describes the Irish plight. It stemmed from cheap credit but the Govt wasn't pressing the banks to do it. They did it themselves.


The Govts. contribution only seems to be deduction of home interest. If heard murmurs of the GOP wanting to do away with that here. If they do, more people will lose their homes.

12/21/2010 7:14 PM  

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