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 Originally Posted by rong
Wuf, read that Krugman article I posted and let me know your thoughts. I'd be interested.
It's a long one, but I read it.
Krugman has diagnosed the main problem with Europe being its monetary policy, and counters Europe's policies by pushing fiscal matters. Wait. What? Indeed Krugman has correctly identified the ECB's shit ass monetary policies, but prescribing fiscal solutions is, um, like drinking water by taking a nap. It's apples and oranges. It's like treating cancer with AIDS medication. It's like Britain counter-attacking Germany in WW2 by invading a shoal of fish in the middle of the North Sea.
If it was that simple, you'd think Krugman would see his mistake, and you'd probably be right. But his real mistake is a little deeper. It's his focus on the zero bound. Through his unwavering position on monetary policy being ineffective at the zero bound, he has provided himself the legroom to salve the Euro monetary problems with fiscal policy. His zero bound stance has some backing, but among the many reasons it is untenable, there are two I know best:
1) His own words. He supports central banking monetary policy so aggressive that it amounts to 4-5% inflation. This is absolutely contradictory to his stance that monetary policy has failed. It really just blows my mind that he has held this contradictory stance for a good five years now. My only explanation for why he can do it is that he rarely discusses inflation, so his inflation suggestions are just meager side notes in his mind. But I really don't know. The economists I currently read think it's because he has endorsed a political stance over his previous economic stance.
2) The monetary offset. What makes central banks central banks is that they hold autonomy over the currency and thus the nominal economy since, numerically, the economy is expressed in terms of that currency. Central banks across the globe have long understood that if they so desire to put the nominal economy at a certain number, they can do so with known policy tools. This means, and has been used numerous times, as an offset to fiscal policy. For example, when a parliament or congress passes a $1T stimulus, it only stimulates as much as the currency controller determines. Fiscal policy is powerless to alter the nominal economy. Historical examples of fiscal policy affecting the nominal economy have only come when the currency controller does not manage expectation with monetary policy.
A recent example of the monetary offset in action can be found in 2013. Krugman was adamant in claiming the across-the-board cuts enacted by the US government would create another recession and about 600k jobs lost. He even went so far as to say it was a test of the power of monetary policy. Well, he lost that test when there was no evidence of his projected job losses and the economy actually improved upon the previous several years, and the only other reasonable correlation was that the Federal Reserve had boosted its monetary stimulus to enough of a point that the fiscal austerity would be more than accounted for. Krugman has since backed away and imagined he never said this was a test.
An even deeper analysis of the fiscal policy position has us scratching our heads, since there is nothing in economics that claims spending increases prosperity. Prosperity is a product of resources moving from or transforming a lower value utility to a higher value utility. Spending doesn't do this and economic metrics even treat savings as the same thing as future spending, so if spending did it, not spending also would.
All in all, Krugman is right in his initial diagnosis of the Europe problem of refractory currency practices. But for some reason his prescriptions are non-sequitur.
It's hard to say much more, because I think the monetary policy of Europe vastly overshadows any fiscal policies. Krugman claims that Europe's monetary policy is in the dumps, but then focuses his energy on a narrative of the real culprit being fiscal policy. I just don't get it.
I think maybe the takeaway is that the theory that fiscal stimulus enhances prosperity is unsound. Most economists are pretty firm on this, but they're losing the battle against populist sentiments and the handful of avowed pundits like Krugman (The Conscience of a Liberal, what a way to stay academically neutral :rollseyes).
FWIW, it does not help us that central banks do not want to boast their role. The Fed, for example, talks out of both sides of its mouth, saying it has lots of policy tools in one breath then saying in the next breath that it would prefer Congress to enact fiscal stimulus. The word is that the Fed doesn't want to own the economy. The populace does not think it owns the economy, so it can get away with putting the responsibility on legislators in order to keep itself in the shadows and off the hook for any problems. Pretty standard boardroom policy IMO.
I'll stop now since this is already too long.
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