Wednesday, August 10, 2011

Krugman Despairs

It is frustrating to know what is happening and to know the right response and be forced to watch people around you either ignorantly fumble with wrong answers or cynically refuse to do the right thing. That's the position Nobel Prize-winning economist Paul Krugman is in.

Here is a post on his NY Times blog where he lays out his despair:
Dismal Thoughts

To be an economist of my stripe these days — basically a Keynes-via-Hicks type, who concluded as soon as Lehman fell that we were in a classic liquidity trap with all that implied — is a bittersweet experience, with the bitter vastly greater than the sweet.

The good news, such as it is, is that our underlying model has performed very well. Interest rates have stayed low despite large government borrowing; crowding out has been totally absent; huge increases in the monetary base have not been highly inflationary.

The bad news is that policy makers almost everywhere have failed dismally, and seem determined not to take on board the lessons of experience, either historical or what we’ve learned the past few years. As Joe Stiglitz says,
When the recession began there were many wise words about having learnt the lessons of both the Great Depression and Japan’s long malaise. Now we know we didn’t learn a thing. Our stimulus was too weak, too short and not well designed. The banks weren’t forced to return to lending. Our leaders tried papering over the economy’s weaknesses – perhaps out of fear that if we were honest about them, already fragile confidence would erode. But that was a gamble we have now lost. Now the scale of the problem is apparent, a new confidence has emerged: confidence that matters will get worse, whatever action we take. A long malaise now seems like the optimistic scenario.
Robert Reich, talking to people in the administration, says that there has been a deliberate decision to focus on the wrong issues, knowing that they’re the wrong issues:
So rather than fight for a bold jobs plan, the White House has apparently decided it’s politically wiser to continue fighting about the deficit. The idea is to keep the public focused on the deficit drama – to convince them their current economic woes have something to do with it, decry Washington’s paralysis over fixing it, and then claim victory over whatever outcome emerges from the process recently negotiated to fix it. They hope all this will distract the public’s attention from the President’s failure to do anything about continuing high unemployment and economic anemia.
And in Europe, says Kantoos Economics, a low inflation target has become a sacred icon even though all evidence – including the experience under the gold standard! — says that this will be fatal:
I sincerely do hope that I read the wrong newspapers and missed all those European economists and commentators screaming all these things (or even better: that I am wrong). But whenever I try to hear something, there is just silence – or Axel Weber lashing out at Olivier Blanchard. Meanwhile, European policy makers and central bankers are wrecking one of the most fascinating projects in human history, the unity and friendship among the countries of Europe. This is beyond depressing. Way beyond.
I’m still trying to make sense of this global intellectual failure. But the results are not in question: we are making a total mess of a solvable problem, with consequences that will haunt us for decades to come.
From a separate post in January 2011 by Paul Krugman, we get this graphic showing the output gap:

Click to Enlarge

Wikipedia offers an explanation of "output gap".

Sadly, the gap has only gotten bigger over the last 9 months as the US economy has hit a "soft patch" which creates even more underperformance and an even greater divergence from trend growth.

As Krugman points out, this tragedy condemns the US (and consequently Canada whose economy is so intertwined with the US) to decades of underperformance. The lost decade(s) that Japan has experienced will be re-experienced here because of failures of leadership at the highest levels. I hold Obama personally responsible and I see the Republican party as guilty of gross incompetence and cynical manipulation of this tragedy for purely political gain. Tens of millions suffer grievously so that a few hundred at the top can pocket billions in ill-gotten gains. Shame!

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