A Simple Economics Lesson

Paul Krugman has a posting on his NY Times blog that teaches a simple lesson: things are not always as they seem. In particular, those running around with their hair on fire about "too big a deficit" simply don't understand deflationary times. Read the following carefully and learn something very important about how the world really works...

Paradoxes Of Deleveraging And Releveraging

Whenever the issue of fiscal stimulus comes up, you can count on someone chiming in to say, “Only a moron could believe that the answer to a problem created by too much debt is to create even more debt.” It sounds plausible — but it misses the key point: there’s a fallacy of composition here. When everyone tries to pay off debt at the same time, the result is contraction and deflation, which ends up making the debt problem worse even if nominal debt falls. On the other hand, a strong fiscal stimulus, by expanding the economy and creating moderate inflation, can actually help resolve debt problems.

Let’s go to the tape here. Below are two time series. The first is total US debt from 1929 to 1948 — public plus private — in billions of dollars. The second is total debt as a percentage of GDP:


From 1929 to 1933, everyone was trying to pay down debt — and the debt/GDP ratio skyrocketed thanks to contraction and deflation. During and immediately after WWII, there was massive borrowing — but GDP grew faster than debt, and the debt burden ended up falling.

Yes, it seems paradoxical — but that’s the kind of world we’re living in. And the refusal of so many people to face up to the fact that we’re in a world where conventional rules don’t apply makes it likely that we’ll stay in that world for a long time come.

The right wing crazies in the US aren't interested in understanding economics and they aren't interested in helping the US get out of its deflationary rut. Their only interest is in winning power. So they are blocking Obama every step of the way. They use common misperceptions like the above, that debts are "bad" so Obama must not spend any money, to hog tie the President and delay the recovery. They are completely irresponsible because most understand that they are "playing politics" and destroying the country they so ardently profess to "love". Tragic.