Paul Krugman has played an indispensable role challenging the conventional wisdom during the financial crisis and the slump that followed. He has been proven right again and again in his brilliant debunking of austerity as the cure for recession.
Therefore, it was astonishing to read a rare, truly wrongheaded Krugman column in Monday’s New York Times. The offending column is titled “A Permanent Slump?”
In it, Krugman proposes that something fundamental—something structural—has changed in the economy so that the new normal is what economists call “secular stagnation,” or as Krugman puts it, “a persistent state in which a depressed economy is the norm, with episodes of full employment few and far between.”
As I read through the column, I kept waiting for the pivot. Surely Krugman was setting up this claim as a straw man, the better to demolish it.
But, no. Krugman evidently buys this view. Even worse, the expert whose research he cites in defense of this thesis is one Lawrence Summers.
Krugman observes, crediting Summers, that consumer demand during the late boom of the 1990s was pumped up by a housing bubble and by people’s habit of increasingly borrowing against their homes. “Without that demand, how can we ever return to full employment?” he wonders. What if prosperity now depends on bubbles? Maybe something demographic accounts for chronically slower growth?
Surely Krugman knows better. For starters, there is the reality of increasing income inequality. If wages and salaries had risen with productivity growth after1978 as they did during the 30-year postwar boom, the average household income would be well in excess of $80,000 and the minimum wage, over $17 an hour.
That equals a lot of demand. People borrowed against their homes because their earnings were flat. Increase earnings and you can have bubble-free growth.
Krugman also knows that in the aftermath of a financial collapse, the economy can stay depressed for prolonged periods in the absence of massive government fiscal intervention. In the late 1930s, when unemployment was stuck in excess of 12 percent, commentators were making arguments much like those in Krugman’s column. High unemployment with stagnant wages was the new reality and we had just better get used to it.
But then Hitler invaded Poland, World War II broke out in Europe, Japan’s empire went on the march and Roosevelt persuaded a reluctant Congress to begin the process of rearming. After the attack on Pearl Harbor, the government entered $100 billion of war production orders in the first six months of 1942.
And a funny thing happened to secular stagnation. It vanished. Unemployment dropped to around 2 percent. For the four war years we grew at an average annual rate of around 12 percent. The war was the greatest accidental Keynesian recovery program of all time.
To pay for all that economic stimulus, we borrowed and taxed. At war’s end, the debt ratio was about 120 percent of GDP. But the war put so much purchasing power in people’s pockets and did so much to recapitalize American industry that the high public debt was no problem at all. The war boom shifted into the postwar consumer boom, and living standards rose steadily for another three decades. The debt gradually fell back to under 30 percent of GDP thanks to all that growth and broadly shared prosperity.
The point is that what looks like “secular stagnation” is often nothing but depressed purchasing power combined with the hangover from a financial collapse. And it could indeed continue indefinitely, just as Krugman’s column warns—unless and until the government gets off the austerity kick. I was on a panel with Krugman when he made exactly that point.
So unless this odd column was intended as a consolation valentine to Larry Summers, it is a mystery why Krugman has shifted ground and embraced an utterly defeatist view. One awaits the follow-up column by Krugman, rebutting Krugman.