May 2012, Week 5


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Tue, 29 May 2012 21:20:31 -0400
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[This is a short(er) version of Paul Krugman's
argument in his just published book of the same title
(Norton) -- moderator.]

How to End This Depression

Paul Krugman
May 24, 2012
New York Review of Books

The depression we're in is essentially gratuitous: we
don't need to be suffering so much pain and destroying
so many lives. We could end it both more easily and more
quickly than anyone imagines-anyone, that is, except
those who have actually studied the economics of
depressed economies and the historical evidence on how
policies work in such economies.

The truth is that recovery would be almost ridiculously
easy to achieve: all we need is to reverse the austerity
policies of the past couple of years and temporarily
boost spending. Never mind all the talk of how we have a
long-run problem that can't have a short-run solution-
this may sound sophisticated, but it isn't. With a boost
in spending, we could be back to more or less full
employment faster than anyone imagines.

But don't we have to worry about long-run budget
deficits? Keynes wrote that "the boom, not the slump, is
the time for austerity." Now, as I argue in my
forthcoming book*-and show later in the data discussed
in this article-is the time for the government to spend
more until the private sector is ready to carry the
economy forward again. At that point, the US would be in
a far better position to deal with deficits,
entitlements, and the costs of financing them.

Meanwhile, the strong measures that would all go a long
way toward lifting us out of this depression should
include, among other policies, increased federal aid to
state and local governments, which would restore the
jobs of many public employees; a more aggressive
approach by the Federal Reserve to quantitative easing
(that is, purchasing bonds in an attempt to reduce long-
term interest rates); and less timid efforts by the
Obama administration to reduce homeowner debt.

But some readers will wonder, isn't a recovery program
along the lines I've described just out of the question
as a political matter? And isn't advocating such a
program a waste of time? My answers to these two
questions are: not necessarily, and definitely not. The
chances of a real turn in policy, away from the
austerity mania of the last few years and toward a
renewed focus on job creation, are much better than
conventional wisdom would have you believe. And recent
experience also teaches us a crucial political lesson:
it's much better to stand up for what you believe, to
make the case for what really should be done, than to
try to seem moderate and reasonable by essentially
accepting your opponents' arguments. Compromise, if you
must, on the policy-but never on the truth.

Let me start by talking about the possibility of a
decisive change in policy direction.

Nothing Succeeds Like Success

Pundits are always making confident statements about
what the American electorate wants and believes, and
such presumed public views are often used to wave away
any suggestion of major policy changes, at least from
the left. America is a "center-right country," we're
told, and that rules out any major initia- tives
involving new government spending.

And to be fair, there are lines, both to the left and to
the right, that policy probably can't cross without
inviting electoral disaster. George W. Bush discovered
that when he tried to privatize Social Security after
the 2004 election: the public hated the idea, and his
attempted juggernaut on the issue quickly stalled. A
comparably liberal-leaning proposal-say, a plan to
introduce true "socialized medicine," making the whole
health care system a government program like the
Veterans Health Administration-would presumably meet the
same fate. But when it comes to the kind of policy
measures I have advocated-measures that would mainly try
to boost the economy rather than try to transform it-
public opinion is surely less coherent and less decisive
than everyday commentary would have you believe.

Pundits and, I'm sorry to say, White House political
operatives like to tell elaborate tales about what is
supposedly going on in voters' minds. Back in 2011 The
Washington Post's Greg Sargent summarized the arguments
Obama aides were using to justify a focus on spending
cuts rather than job creation:

     A big deal would reassure independents who fear the
     country is out of control; position Obama as the
     adult who made Washington work again; allow the
     President to tell Dems he put entitlements on
     sounder financial footing; and clear the decks to
     enact other priorities later.

Any political scientist who has actually studied
electoral behavior will scoff at the idea that voters
engage in anything like this sort of complicated
reasoning. And political scientists in general have
scorn for what Slate's Matthew Yglesias calls the
pundit's fallacy, the belief on the part of all too many
political commentators that their pet issues are,
miraculously, the very same issues that matter most to
the electorate.

Most real voters are busy with their jobs, their
children, and their lives in general. They have neither
the time nor the inclination to study policy issues
closely, let alone engage in opinion-page-style parsing
of political nuances. What they notice, and vote on, is
whether the economy is getting better or worse;
statistical analyses say that the rate of economic
growth in the three quarters or so before the election
is by far the most important determinant of electoral

What this says-a lesson that the Obama team
unfortunately failed to learn until very late in the
game-is that the economic strategy that works best
politically isn't the strategy that finds approval with
focus groups, let alone with the editorial page of The
Washington Post; it's the strategy that actually
delivers results. Whoever is sitting in the White House
next year will best serve his own political interests by
doing the right thing from an economic point of view,
which means doing whatever it takes to end the
depression we're in. If expansionary fiscal and monetary
policies coupled with debt relief are the way to get
this economy moving, then those policies will be
politically smart as well as in the national interest.

But is there any chance of actually getting them enacted
as legislation?

Political Possibilities

It's not at all clear what the political landscape will
look like after the election. But there do seem to be
three main possibilities: President Obama is reelected
and Democrats also regain control of Congress; Mitt
Romney wins the presidential election and Republicans
add a Senate majority to their control of the House; the
president is reelected but faces at least one hostile
house of Congress. What can be done in each of these

The first case-Obama triumphant-obviously makes it
easiest to imagine America doing what it takes to
restore full employment. In effect, the Obama
administration would get an opportunity at a do-over,
taking the strong steps it failed to take in 2009. Since
Obama is unlikely to have a filibuster-proof majority in
the Senate, taking these strong steps would require
making use of reconciliation, the procedure that the
Democrats used to pass health care reform and that Bush
used to pass both of his tax cuts. So be it. If nervous
advisers warn about the political fallout, Obama should
remember the hard-learned lesson of his first term: the
best economic strategy from a political point of view is
the one that delivers tangible progress.

A Romney victory would naturally create a very different
situation; if Romney adhered to Republican orthodoxy, he
would of course reject any government action along the
lines I've advocated. It's not clear, however, whether
Romney believes any of the things he is currently
saying. His two chief economic advisers, Harvard's N.
Gregory Mankiw and Columbia's Glenn Hubbard, are
committed Republicans but also quite Keynesian in their
views about macroeconomics. Indeed, early in the crisis
Mankiw argued for a sharp rise in the Fed's target for
inflation, a proposal that was and is anathema to most
of his party. His proposal caused the predictable
uproar, and he went silent on the issue. But we can at
least hope that Romney's inner circle holds views that
are much more realistic than anything the candidate says
in his speeches, and that once in office he would rip
off his mask, revealing his true pragmatic, Keynesian

Of course, a great nation should not have to depend on
the hope that a politician is in fact a complete fraud
who doesn't believe any of the things he claims to
believe. And such a hope is certainly not a reason to
vote for that politician. Still, making the case for job
creation may not be a wasted effort, even if Republicans
take it all this November.

Finally, what about the fairly likely case in which
Obama is returned to office but a Democratic Congress is
not? What should Obama do, and what are the prospects
for action? My answer is that the president, other
Democrats, and every Keynesian-minded economist with a
public profile should make the case for job creation
forcefully and often, and keep pressure on those in
Congress who are blocking job-creation efforts.

This is not the way the Obama administration operated
for its first two and a half years. We now have a number
of reports on the internal decision-making processes of
the administration from 2009 to 2011, and they all
suggest that the president's political advisers urged
him never to ask for things he might not get, on the
grounds that it might make him look weak. Moreover,
economic advisers like Christina Romer who urged more
spending on job creation were overruled on the grounds
that the public didn't believe in such measures and was
worried about the deficit.

The result of this caution was, however, that as even
the president bought into deficit obsession and calls
for austerity, the whole national discourse shifted away
from job creation. Meanwhile, the economy remained weak-
and the public had no reason not to blame the president,
since he wasn't staking out a position clearly different
from that of the GOP.

In September 2011 the White House finally changed tack,
offering a job-creation proposal that fell far short of
what was needed, but was nonetheless much bigger than
expected. There was no chance that the plan would
actually pass the Republican-led House of
Representatives, and Noam Scheiber of The New Republic
tells us that White House political operatives "began to
worry that the size of the package would be a liability
and urged the wonks to scale it back." This time,
however, Obama sided with the economists-and in the
process proved that the political operatives didn't know
their own business. Public reaction was generally
favorable, while Republicans were put on the spot for
their obstruction.

And early this year, with the debate having shifted
perceptibly toward a renewed focus on jobs, Republicans
were on the defensive. As a result, the Obama
administration was able to get a significant fraction of
what it wanted-an extension of the payroll tax credit,
not an ideal stimulus but nonetheless a measure that
puts cash in workers' pockets, and maintenance for a
shorter period of extended unemployment benefits-without
making any major concessions.

Interim Archives/Getty Images
An unemployed man selling apples during the Great
Depression, circa 1930s

In short, the experience of Obama's first term suggests
that not talking about jobs simply because you don't
think you can pass job-creation legislation doesn't work
even as a political strategy. On the other hand,
hammering on the need for job creation can be good
politics, and it can put enough pressure on the other
side to bring about better policy too.

Or to put it more simply, there is no reason not to tell
the truth about this depression.

A Moral Imperative

It has been more than four years since the US economy
first entered recession-and although the recession may
have ended, the depression has not. Unemployment may be
trending down a bit in the United States (though it's
rising in Europe), but it remains at levels that would
have been inconceivable not long ago-and are
unconscionable now. Tens of millions of our fellow
citizens are suffering vast hardship, the future
prospects of today's young people are being eroded with
each passing month-and all of it is unnecessary.

For the fact is that we have both the knowledge and the
tools to get out of this depression. Indeed, by applying
time-honored economic principles whose validity has only
been reinforced by recent events, we could be back to
more or less full employment very fast, probably in less
than two years. All that is blocking recovery is a lack
of intellectual clarity and political will.

But one question remains. I have argued that in a deeply
depressed economy, in which the interest rates that the
monetary authorities can control are near zero, we need
more, not less, government spending. A burst of federal
spending is what ended the Great Depression, and we
desperately need something similar today.

Yet how do we know that more government spending would
actually promote growth and employment? After all, many
politicians fiercely reject that idea, insisting that
the government can't create jobs; some economists are
willing to say the same thing. So is it just a question
of going with the people who seem to be part of your
political tribe?

Well, it shouldn't be. Tribal allegiance should have no
more to do with your views about macroeconomics than
with your views on, say, the theory of evolution or
climate change. The question of how the economy works
should be settled on the basis of evidence, not
prejudice. And one of the few benefits of this
depression has been a surge in evidence-based economic
research into the effects of changes in government
spending. What does that evidence say?

Before I can answer that question, I have to talk
briefly about the pitfalls one needs to avoid.

The Trouble with Correlation

You might think that the way to assess the effects of
government spending on the economy is simply to look at
the correlation between spending levels and other things
like growth and employment. The truth is that even
people who should know better sometimes fall into the
trap of equating correlation with causation. But let me
try to disabuse you of the notion that this is a useful
procedure by talking about a related question: the
effects of tax rates on economic performance.

It's an article of faith on the American right that low
taxes are the key to economic success. But suppose we
look at the relationship between taxes-specifically, the
share of GDP collected in federal taxes-and unemployment
over the past dozen years. What we find is that years
with high tax shares were years of low unemployment, and
vice versa (see Figure 1). Clearly, isn't the way to
reduce unemployment to raise taxes?

Even those of us who very much disagree with tax-cut
mania don't believe this. Why not? Because we're surely
looking at spurious correlation here. For example,
unemployment was relatively low in 2007 because the
economy was still buoyed by the housing boom-and the
combination of a strong economy and large capital gains
boosted federal revenues, making taxes look high. By
2010 the boom had gone bust, taking both the economy and
tax receipts with it. Measured tax levels were a
consequence of other things, not an independent variable
driving the economy.

Similar problems bedevil any attempt to use historical
correlations to assess the effects of government
spending. If economics were a laboratory science, we
could solve the problem by performing controlled
experiments. But it isn't. Econometrics-a specialized
branch of statistics that's supposed to help deal with
such situations-offers a variety of techniques for
"identifying" actual causal relationships. The truth,
however, is that even economists are rarely persuaded by
fancy econometric analyses, especially when the issue at
hand is so politically charged. What, then, can be done?

The answer in much recent work has been to look for
"natural experiments"-situations in which we can be
pretty sure that changes in government spending are
neither responding to economic developments nor being
driven by forces that are also moving the economy
through other channels. Where do such natural
experiments come from? Sadly, they mainly come from
disasters-wars or the threat of wars, and fiscal crises
that force governments to slash spending regardless of
the state of the economy.

Disasters, Guns, and Money

As I wrote, since the crisis began there has been a boom
in research into the effects of fiscal policy on output
and employment. This body of research is growing fast,
and much of it is too technical to be summarized in this
article. But here are a few highlights.

First, Stanford's Robert Hall has looked at the effects
of large changes in US government purchases-which is all
about wars, specifically World War II and the Korean
War. Figure 2 on this page compares changes in US
military spending with changes in real GDP-both measured
as a percentage of the preceding year's GDP-over the
period from 1929 to 1962 (there's not much action after
that). Each dot represents one year; I've labeled the
points corresponding to the big buildup during World War
II and the big demobilization just afterward. Obviously,
there were big moves in years when nothing much was
happening to military spending, notably the slump from
1929 to 1933 and the recovery from 1933 to 1936. But
every year in which there was a big spending increase
was also a year of strong growth, and the reduction in
military spending after World War II was a year of sharp
output decline.

This clearly suggests that increasing government
spending does indeed create growth and hence jobs. The
next question is, how much bang is there per buck? The
data on US military spending are slightly disappointing
in that respect, suggesting that a dollar of spending
actually generates only about fifty cents of growth. But
if you know anything about wartime history, you realize
that this may not be a good guide to what would happen
if we increased spending now. After all, during World
War II private-sector spending was deliberately
suppressed by rationing and restrictions on private
construction; during the Korean War, the government
tried to avoid inflationary pressures by sharply raising
taxes. So it's likely that an increase in spending now
would yield bigger gains.

How much bigger? To answer that question, it would be
helpful to find natural experiments telling us about the
effects of government spending under conditions more
like those we face today. Unfortunately, there aren't
any such experiments as good and clear-cut as World War
II. Still, there are some useful ways to get at the

One is to go deeper into the past. As the economic
historians Barry Eichengreen and Kevin O'Rourke point
out, during the 1930s European nations entered, one by
one, into an arms race, under conditions of high
unemployment and near-zero interest rates resembling
those prevailing now. In work with their students, they
have used the admittedly scrappy data from that era to
estimate the impact that spending changes driven by that
arms race had on output, and have come up with a much
bigger bang for the buck (or, more accurately, the lira,
mark, franc, and so on).

Another option is to compare regions within the United
States. Emi Nakamura and Jon Steinsson of Columbia
University point out that some US states have long had
much bigger defense industries than others-for example,
California has had a large concentration of defense
contractors, whereas Illinois has not. Meanwhile,
defense spending at the national level has fluctuated a
lot, rising sharply under Reagan, then falling after the
end of the cold war. At the national level, the effects
of these changes are obscured by other factors,
especially monetary policy: the Fed raised rates sharply
in the early 1980s, just as the Reagan buildup was
occurring, and cut them sharply in the early 1990s. But
you can still get a good sense of the impact of
government spending by looking at the differential
effect across states; Nakamura and Steinsson estimate,
on the basis of this differential, that a dollar of
spending actually raises output by around $1.50.

So looking at the effects of wars-including the arms
races that precede wars and the military downsizing that
follows them-tells us a great deal about the effects of
government spending. But are wars the only way to get at
this question?

When it comes to big increases in government spending,
the answer, unfortunately, is yes. Big spending programs
rarely happen except in response to war or the threat
thereof. However, big spending cuts sometimes happen for
a different reason: because national policymakers are
worried about large budget deficits and/or debts, and
slash spending in an attempt to get their finances under
control. So austerity, as well as war, gives us
information on the effects of fiscal policy.

It's important, by the way, to look at the policy
changes, not just at actual spending. Like taxes,
spending in modern economies varies with the state of
the economy, in ways that can produce spurious
correlations; for example, US spending on unemployment
benefits has soared in recent years, even as the economy
weakened, but the causation runs from unemployment to
spending rather than the other way around. Assessing the
effects of austerity therefore requires painstaking
examination of the actual legislation used to implement
that austerity.

Fortunately, researchers at the International Monetary
Fund have done the legwork, identifying no fewer than
173 cases of fiscal austerity in advanced countries over
the period between 1978 and 2009. And what they found
was that austerity policies were followed by economic
contraction and higher unemployment.

There's much, much more evidence, but I hope this brief
overview gives a sense of what we know and how we know
it. I hope in particular that when you read me or Joseph
Stiglitz or Christina Romer saying that cutting spending
in the face of this depression will make it worse, and
that temporary increases in spending could help us
recover, you won't think, "Well, that's just his/her
opinion." As Romer asserted in a recent speech about
research into fiscal policy:

     The evidence is stronger than it has ever been that
     fiscal policy matters-that fiscal stimulus helps
     the economy add jobs, and that reducing the budget
     deficit lowers growth at least in the near term.
     And yet, this evidence does not seem to be getting
     through to the legislative process.

That's what we need to change.


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