Paul Krugman warns against fiscal stimulus

This is Paul Krugman on the effectiveness on fiscal policy and why fiscal “stimulus” will in fact not be stimulative:

“The US is currently engaged in the largest peacetime fiscal stimulus in history, with a budget deficit of around 10 percent of GDP. And this stimulus is working in the narrow sense that it has headed off the imminent risk of a deflationary spiral, and generated some economic growth. On the other hand, deficits this size cannot be continued over the long haul; USA now has Italian (or Belgian) levels of internal debt, together with large implicit liabilities associated with its awkward demographics. So the current strategy can work in the larger sense only if it succeeds in jump-starting the economy, in eventually generating a self-sustaining recovery that persists even after the stimulus is phased out.

Is this likely? The phrase “self-sustaining recovery” trips lightly off the tongue of economic officials; but it is in fact a remarkably exotic idea. The purpose of this note is to expose this hidden exoticism – to show that anyone who believes that temporary fiscal stimulus will produce sustained recovery is implicitly endorsing a rather fancy economic model, the sort of model that finance ministries would under normal circumstances regard as implausible and disreputable…

…What continues to amaze me is this: USA’s current strategy of massive, unsustainable deficit spending in the hopes that this will somehow generate a self-sustained recovery is currently regarded as the orthodox, sensible thing to do – even though it can be justified only by exotic stories about multiple equilibria, the sort of thing you would imagine only a professor could believe. Meanwhile further steps on monetary policy – the sort of thing you would advocate if you believed in a more conventional, boring model, one in which the problem is simply a question of the savings-investment balance – are rejected as dangerously radical and unbecoming of a dignified economy.”

Wauw! What is this? What happened to the keynesian Krugman? Isn’t he calling for fiscal easing anymore? Well yes, but I am cheating here. This is Paul Krugman, but it is not today’s Paul Krugman. This is Paul Krugman in 1999 – and he is talking about Japan and not the US. I simply replaced “Japan” with “the US” in the Krugman quote above.

Read the entire article here.

HT Tyler Cowen and Vaidas Urba.

Leave a comment


  1. W. Peden

     /  October 26, 2012

    That qualifies as a “gotcha!” moment, I think. 🙂

  2. What a tease. I thought Krugman was starting to become more practical instead of partisan.

  3. Leszek

     /  October 26, 2012

    Don’t forget that in the eighties Krugman was working for the Reagan administration. If he continues to evolve like this he’ll end as a Stalinist.
    Can you believe that he attacked the Baltic states for their austerity and structural reforms? They are the example to follow. Our policy objectives should be guided by objective libertarian-monetarist principles, not by some misguided ‘pity’ for the weak and the unemployed. We should have strong businessmen at the top of society. Unemployed have to be forced to lower their wage expectations untill demand and supply of labor match, if this doesn’t work they have to be forced out of the country like Latvia does so well. And the ones who remain can rot away, drinking. Who needs them anyway? These unproductive weaklings. I hope that one day all of Europe will follow the example of the Baltic states.

    • Leszek, let me first of all say that I certainly do not agree with you that unemployment people are “weaklings” as you claim. Rather most unemployed in Europe are unemployed because of the ECB’s failed monetary policies – and failed labour market regulation.

      Furthermore, the Baltic countries did a lot of right things over the past 4 years, but the policy mistakes are certainly also numerous and I can find much better examples of countries to copy in terms of how to handle this crisis.

      • Leszek

         /  October 26, 2012

        Dear Mr Christensen,

        What are/were their biggest policy mistakes according to you? And what better examples can you find? Sweden for example? Budget deficit near zero, devaluation of the currency and very loose monetary policy, and very strong growth after the recession in 2009. On that I would agree with you, but do you think that independent monetary policy is feasible for the Baltic states?

    • Sylvia Nicholls

       /  October 30, 2012

      So there still are people who suscribe to the Darwinian survival of the fittest theory! How comical and laughable I find your prescription of how the unemployed should be treated. Let’s see how you will cope when you hit rock bottom, as we all end up doing sooner or later, one way or the other. May your harsh cruel words then haunt you ….

  4. Becky Hargrove

     /  October 26, 2012

    Aaaaaah! You tricked me. And I should know better! Good way to point out the “changed” Krugman, however.

  5. Interesting year, 1999. That´s the year Bernanke adised Japan to undertake expansionary monetary policy. Now we learn that Krugman did the same thing, with other words! All the while downplaying fiscal stimulus.

  6. Something else Krugman said was quite revealing, however.

    “The point is that multiple equilibria are too easy – they are a device that can justify practically any policy, and should therefore not be proposed unless you have some compelling reason to think they must be there.

    Now you could argue that the experience of the Depression and after provides just such evidence. Many economists thought that with the end of World War II spending the United States would revert to Depression-type conditions; a whole school of thought, the “secular stagnation” hypothesis, was built around that idea. In fact, once jolted out of depression, the U.S. did not fall back; one explanation is a story something like that in Figure 2.

    But it is quite a stretch to argue that Japan in the 90s is a parallel case.”

    Krugman thinks that today’s situation is more like the Great Depression than post-90s Japan, and ’99 Krugman thinks that fiscal stimulus is what got America out of the Great Depression.

    Maybe he’s right. I don’t think he is, but the way you show that he’s wrong isn’t by dredging up something ostensibly contradictory that he wrote in the past. It’s by arguing coherently and persuasively either that a) fiscal stimulus worked in the Depression but wouldn’t work now for some reason or b) it wasn’t self-financing fiscal stimulus that generated recovery in the 30s and 40s but rather monetary expansion.

    I think b) is probably the right angle.

    • Theo, you surely have a point. I also noted that Krugman had to say about “multiple equilibria” and maybe it is here that his changed his mind. However, it it also notable that while Krugman only recently has advocated monetary easing in the US – remember initially he was rather critical about monetary easing and flat out advocated fiscal stimulus.

  7. The thing is, this discussion of the value of fiscal stimulus as a temporary vs permanent solution should be included in all the undergraduate textbooks – but isn’t.

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