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Paul Krugman Sends Us to Martin Wolf on Death By Accounting Identity

Paul Krugman:

Death By Accounting Identity: Martin Wolf has a somewhat despairing-sounding column this morning, in effect pleading with the Cameron government to admit that the laws of arithmetic must apply. Good luck with that. Martin writes,

If the private sector is seeking to run down its debts, it is hard for the government to do so, too, because everybody cannot spend less than their income. That is the “paradox of thrift”. No, it is not a novel idea.

Ah, but for the past two years leaders in the Eurozone, Britain, and the US Republican party have subscribed to the following plan: 1. Slash government spending. 2. ??????. 3. Prosperity! For a while ???? was framed in terms of the doctrine of expansionary austerity: slash spending and the confidence fairy would make private-sector spending rise. At this point, however, few still believe in this doctrine. Also, in the euro area it was hard to see how things would work even if the confidence fairy made an appearance; how was that supposed to resolve the large payments imbalances between the core and the periphery?

But even as the intellectual foundations, such as they were, for the austerity plan have been demolished, the plan itself remains unchanged.

Martin Wolf:

Why cutting fiscal deficits is an assault on profits: Reducing the government’s debt was “proving harder than anyone envisaged”, David Cameron, UK prime minister, said in a speech on Monday. He even admitted that “high levels of public and private debt are proving to be a drag on growth, which in turn makes it more difficult to deal with those debts”. Yet, if Mr Cameron had wanted to do so, he could have met many “anyones” who would have warned him of what he has now learnt, at great cost to the country. If the private sector is seeking to run down its debts, it is hard for the government to do so, too, because everybody cannot spend less than their income. That is the “paradox of thrift”. No, it is not a novel idea.

If the government wishes to cut its deficits, other sectors must save less…. If the government is running a huge financial deficit – that is, spending vastly more than its revenue – then other sectors must be spending much less than their income. And so, indeed, they are…. In order to reduce huge government deficits, surpluses must fall elsewhere. But one should want that adjustment to occur via higher spending rather than via a collapse of the economy into a deeper slump….

The surplus of corporations is the gap between their retained earnings and investments. This can be lowered by raising investment…. What are the chances of a surge in corporate investment when households are deleveraging, the country’s export markets are in trouble, and the government is curbing spending> Negligible….

[T]o offset reductions in fiscal deficits, pay-outs must rise or retained profits fall…. Yet that would mean a still-weaker economy, since reduced profits would also lower investment. That would be a disaster, in the short and long term….

I find the government’s programme of fiscal tightening unreasonably inflexible in such an uncertain world. It would make good sense to introduce credibly temporary fiscal boosts, particularly when monetary policy seems rather ineffective, at least on its own….

If the government is dead set on rejecting such pleas, it has to show how the rest of the economy is to adjust to its lower deficits. That has to start with the corporate sector, where the vast bulk of the financial surpluses now reside. If profits are not to be slashed, what is to change and how? That is a serious question. The public deserves a decent answer.

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