Yes, Paul Krugman, Booms Are Unsustainable

Once the blame game starts, then Krugman and other Keynesians will demand that government engage in various policies—and especially borrowing and spending—to bring back those lofty levels of so-called aggregate demand and the high prices that accompany such demand. This hardly is a new strategy. The original New Deal policies from Franklin D. Roosevelt (as opposed to the nearly identical New Deal policies from Herbert Hoover) were based upon the belief that falling prices were the main cause of the depression and that government needed to force up agricultural, commodity, and labor prices in order to right the economic ship. Thus, the government tried to cartelize the entire nonfarm economy through the National Industrial Recovery Act and prop up farm prices through the Agricultural Adjustment Act, both of 1933. In 2008, Martin Feldstein, President Reagan’s chief economic adviser, sounded the same horn on housing, declaring in The Wall Street Journal that the chief culprit of the 2008 meltdown was falling prices in housing:

A successful plan to stabilize the U.S. economy and prevent a deep global recession must do more than buy back impaired debt from financial institutions. It must address the fundamental cause of the crisis: the downward spiral of house prices that devastates household wealth and destroys the capital of financial institutions that hold mortgages and mortgage-backed securities.

One could write volumes about the economic fallacies contained in that paragraph, but readers get the point. In Keynesian land, there are no economic fundamentals, no relationships between factors of production, just spending. Spend enough money and policymakers can keep factors of production employed indefinitely; when the inevitable dislocations appear, paper them over with even more spending and let the good times roll and roll and roll.

Austrians, according to Krugman, are the authors of a very bad morality play when it comes to diagnosing and analyzing booms and busts:

The hangover theory (what Krugman calls the Austrian Business Cycle Theory) is perversely seductive—not because it offers an easy way out, but because it doesn’t. It turns the wiggles on our charts into a morality play, a tale of hubris and downfall. And it offers adherents the special pleasure of dispensing painful advice with a clear conscience, secure in the belief that they are not heartless but merely practicing tough love. Powerful as these seductions may be, they must be resisted—for the hangover theory is disastrously wrongheaded. Recessions are not necessary consequences of booms. They can and should be fought, not with austerity but with liberality—with policies that encourage people to spend more, not less.

Krugman wrote this more than twenty years ago but has not changed his views since then. Not surprisingly, he reduces accounts of mal-investment—in fact, he doesn’t even use that term, wrongly calling it “overinvestment” instead—to mere moral tut-tuts which actually are dangerous because Austrians, in Krugman’s view, malevolently urge people to stop spending at a time when increased spending is needed most. In short, booms are good, always good. Booms bring prosperity, and anything that discourages prosperity is bad, end of argument.

This analysis misjudges both booms and busts, which the current political and academic climate tends to reward rather than punish. (Robert Murphy goes into detail about Krugman’s errors in this article, one well worth reading.) If Krugman believes booms are good and should be maintained perpetually, then it is reasonable to believe that anything less that outright condemnation of a bust borders on being immoral. When that viewpoint is combined with Krugman’s increasing left-wing radicalism, it is not hard to understand his unrelenting hostility to Austrians and their viewpoints. When he first criticized the Austrian business cycle theory in 1998, his take was that Austrians were wrong, dismissively so, but he stopped there. Today, he wants readers to believe that Austrians are Evil People who want others to live in poverty and starve to death. We no longer are dealing with intellectual disagreements but rather a titanic battle between the Forces of Good and Evil and Krugman is on the side of Good. One cannot argue with anyone defending free markets and market prices because, in his words, “the mendacity is the message.”

Krugman’s radicalism notwithstanding, we still must deal with his argument that economic booms not only are desirable but that they can be sustained indefinitely with no resulting damage to the economy. This is not to say that a sustained boom contains no fluctuations; even Krugman admits that, but he also believes that government simply can make adjustments on the fly to even the rough places, something that requires the election of like-minded progressives that believe government can work near economic miracles.

Why, then, do Austrians hold that booms cannot be sustained? First, and most important, Austrians point out that the conditions that create the boom are not benign. Booms occur when monetary authorities (i.e., Federal Reserve System or some other national central bank) hold interest rates below market levels by expanding the supply of money for the purpose of expanding borrowing for business expansion. This increases the demand for capital goods (and factors of production associated with their creation) and puts new money into the hands of employees in those associated industries. The employees spend the money on consumer goods, creating new demand for those products.

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