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Notes on Paul Krugman: 1937 and 2010

Paul Krugman:

A Global 1937: Back in 2009, when there was (briefly) a policy consensus in favor of active fiscal policy to fight the slump, there were many warnings to the effect that we must not repeat the infamous mistake of 1937, in which FDR was persuaded to focus on balancing the budget while the economy was still weak, terminating the recovery from 1933 and sending America into the second leg of the Great Depression. And what policy makers proceeded to do was, of course, to repeat the mistake of 1937. The new IMF World Economic Outlook is, in effect, an extensively documented exercise in hand-wringing over the consequences…. Kudos to the Fund for having the courage to say this….

There is, however, one point I think is getting skewed… unforced austerity in countries that remain able to borrow very cheaply…. [E]ven cheap-money countries facing no pressure either from the market or from external forces to engage in immediate austerity are nonetheless engaged in sharp fiscal contraction… [as] the private sector is still deleveraging ferociously…. And whaddya know, the world economy is sputtering.

The truly amazing thing is that this calamitous error is not, for the most part, the result of special interests, or an unwillingness to make hard choices. On the contrary, it’s being driven by Very Serious People who pride themselves on their willingness to make hard choices (which, naturally, involve inflicting pain on other people)…. FT Alphaville says that I’m feeling a bit “smuggish” about all this; well, I’m only human. But truly, this is a terrible thing to behold.

Isabella Kaminska:

The IMF game changer:

Christine Lagarde has urged countries to put a brake on austerity measures amid signs that the IMF is becoming increasingly concerned about the impact of government cutbacks on growth…. The fund warned earlier this week that governments around the world had systematically underestimated the damage done to growth by austerity. That’s from Thursday’s front page story on FT.com. To say it’s a big deal is possibly understating….

The fact of the matter is that the IMF has played bad cop to the global economy for generations now, enforcing austerity, conditionality and accountability wherever it goes…. The key point, we think, is that what we are discovering is that [the fiscal multiplier] is variable. And that in some economic conditions it works much more effectively than we ever possibly hoped. It’s no surprise that Paul Krugman… is feeling a bit smuggish… (and rightly so)….

[T]he key game changing finding from the IMF report is that activity over the past few years has disappointed more in economies which were implementing aggressive fiscal consolidation plans than those that weren’t. Which means the contractionary effects of fiscal consolidation are substantially bigger than policy makers were assuming.

The question is, what will the political elite do with this knowledge? Also, to what degree will the IMF have to stage a “we’re sorry” campaign?

Lastly, if we do all agree that more fiscal stimulus is needed, how do we ensure that stimulus is correctly distributed — and by that we mean to industries of tomorrow rather than to flailing industries of the past?

And Claire Jones and Peter Spiegel:

Schäuble and Lagarde clash over austerity: SchHigh-level splits over the handling of the eurozone crisis burst into the open on Thursday when Germany’s finance minister rebuked the head of the International Monetary Fund after she warned that EU leaders should ease demands for tighter austerity in peripheral economies. Wolfgang Schäuble said Christine Lagarde had appeared to contradict the IMF’s own stance in advocating an easing of austerity, noting that the fund had “time and again” warned that high debt levels threatened economic growth.

From my perspective, what Schäuble does not know--and has spent a long time trying hard not to learn--is an old Abba Lerner point: when governments can borrow at less than zero and have productive things to do with the money, whether those productive things are infrastructure investments or Keynesian stimulus, the government should doing so. And doing so does not add to but rather reduces the net effective debt burden. If Herr Schäuble truly wants low government debt-to-GDP ratios in Europe, he should be pressing hard for faster demand expansion and a stronger recovery in Europe right now.

He is not.

The FT:

Ms Lagarde said eurozone countries should not blindly stick to tough budget deficit targets if growth weakens more than expected. She argued that they should allow “automatic stabilisers” – higher welfare spending and lower tax revenues – to kick in if the economy deteriorated…. The IMF’s warnings against an overreliance on austerity came as Angela Merkel, the German chancellor, held out the prospect of government action, including possible tax cuts, to stimulate domestic demand. Ms Merkel said she was determined to revive Germany’s flagging growth…. Ms Lagarde advocated giving Greece two more years to hit the tough budget targets contained in its €174bn bailout programme, becoming the most senior official publicly to back to a request from the government in Athens…. Ms Lagarde said she also supported the European Commission’s decision to give Spain another year to bring its budget deficit down to 3 per cent of economic output…

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