A recent article by Paul Krugman titled " Europe's economic crisis: the gap between 'need' and 'do' " in the Seattle Times recommends some serious Keynesian medicines for the European economic problems. Mr. Krugman recommends a path of fiscal expansion as the solution to the recent recessionary scenario. The logic and intuition he uses come from the hallowed Keynesian tradition, which says that expanding money supply or fiscal expansion can counteract depressed demand or investment sentiments in the economy. Keynesian approaches do have their uses and some of the economic woes of recent times may be attributable to the inability to come up with Keynesian solutions at the right moment in time. However, recommending fiscal expansion in the current scenario in the PIGS ( Portugal, ireland, Greece, Spain ) countries, for example, has its own serious problems. What form will this fiscal expansion take ? Will it involve higher spending on infrastructure ? But we have already seen what has happened in Japan with low-tax, high infrastructure spending Keynesian medicines. In one word, doldrums. Will the PIGS countries go the way of Japan if Mr.Krugman's policy recommendations are followed ? Will Europe go the way of Japan if Mr. Krugman's policy recommendations are followed ? These are useful questions to ponder. No one should be under the illusion that the situation is an easy one. And no one wants Europe or the whole world to look like Japan, with two decades of economic stagnation and a deb-to-GDP ratio of 200%.
Mr. Krugman should do well to remember that credit rating agencies downgraded the treasury bonds of several European countries before they had the chance to embark on the kind of Keynesian expansion he suggests. While the EFSF and similar mechanisms are providing funding, they are unlikely to accommodate the kind of approaches that Mr. Krugman suggests. The ability to repay debt has always been a major consideration for this kind of mechanism, and it should be to some extent ( the danger is that they may be too insensitive to short-run considerations just as Mr. Krugman is oblivious to many long-term considerations ). Also, Mr. Krugman needs to tell us whether tax increases should form a component of a long-term stabilization strategy. Tax increases are anathema to Keynesian thinking, but who says Keynesians do not have huge lacunae in their theoretical frameworks ? In fact, Mr. Krugman needs to clarify what he means by fiscal expansion. Does he want to keep tax rates unchanged and just go for spending increases, or is he considering a mix ? The devil is in the details and Mr. Krugman's recommendation of fiscal expansion is not detailed enough to lead to workable solutions at the moment.
The housing market glut is a systemic problem. It can take years for the market to come to the right equilibrium and for its negative effects on the rest of the economy to be alleviated. Keynesian measures in the form of monetary expansion, tax rebates and bailouts were implemented in the United States, but we are still hovering close to a double-dip recession. And the housing market is still searching for the right equilibrium. And the debt-to-GDP ratio keeps skyrocketing and the stage is being set for a debt default crisis a few years or may be a decade from now. What is the guarantee that Europe won't experience the same fate ?
Mr. Krugman is throwing caution to the winds by ignoring possible long-term problems when he makes such a recommendation. The governments of these countries have to juggle considerations of current recession, current unemployment, short-term and medium-term and long-term debt sustainability and the trajectory of debt-to-GDP ratios. What is needed is a right mix between short-run stability and long-run sustainability. And Mr. Krugman fails to consider the latter in his solutions. If Japan is any guide, his notion of a stimulus can look like irresponsible profligacy in hindsight a few years from now. Keynesianism is a framework that deals with short-run problems. Today, we are faced with some historically unprecedented scenarios where not only is the short-run bad, but the long-run looks scary as hell too. And the long run looks scary not just imprecisely, or intuitively, but quite precisely and rather predictably. For example, the debt-to-GDP ratio that the future generations will inherit is a serious and predictable long-term problem. Any solution that fails to take account of both is likely to exacerbate the overall situation. Austerity now for stability later may not be such a bad idea. What may work is not profligate Keynesianism, but a toned-down, detail-oriented Keynesianism that is not insensitive to critical long-run considerations.
by C. Jayant Praharaj
Mr. Krugman should do well to remember that credit rating agencies downgraded the treasury bonds of several European countries before they had the chance to embark on the kind of Keynesian expansion he suggests. While the EFSF and similar mechanisms are providing funding, they are unlikely to accommodate the kind of approaches that Mr. Krugman suggests. The ability to repay debt has always been a major consideration for this kind of mechanism, and it should be to some extent ( the danger is that they may be too insensitive to short-run considerations just as Mr. Krugman is oblivious to many long-term considerations ). Also, Mr. Krugman needs to tell us whether tax increases should form a component of a long-term stabilization strategy. Tax increases are anathema to Keynesian thinking, but who says Keynesians do not have huge lacunae in their theoretical frameworks ? In fact, Mr. Krugman needs to clarify what he means by fiscal expansion. Does he want to keep tax rates unchanged and just go for spending increases, or is he considering a mix ? The devil is in the details and Mr. Krugman's recommendation of fiscal expansion is not detailed enough to lead to workable solutions at the moment.
The housing market glut is a systemic problem. It can take years for the market to come to the right equilibrium and for its negative effects on the rest of the economy to be alleviated. Keynesian measures in the form of monetary expansion, tax rebates and bailouts were implemented in the United States, but we are still hovering close to a double-dip recession. And the housing market is still searching for the right equilibrium. And the debt-to-GDP ratio keeps skyrocketing and the stage is being set for a debt default crisis a few years or may be a decade from now. What is the guarantee that Europe won't experience the same fate ?
Mr. Krugman is throwing caution to the winds by ignoring possible long-term problems when he makes such a recommendation. The governments of these countries have to juggle considerations of current recession, current unemployment, short-term and medium-term and long-term debt sustainability and the trajectory of debt-to-GDP ratios. What is needed is a right mix between short-run stability and long-run sustainability. And Mr. Krugman fails to consider the latter in his solutions. If Japan is any guide, his notion of a stimulus can look like irresponsible profligacy in hindsight a few years from now. Keynesianism is a framework that deals with short-run problems. Today, we are faced with some historically unprecedented scenarios where not only is the short-run bad, but the long-run looks scary as hell too. And the long run looks scary not just imprecisely, or intuitively, but quite precisely and rather predictably. For example, the debt-to-GDP ratio that the future generations will inherit is a serious and predictable long-term problem. Any solution that fails to take account of both is likely to exacerbate the overall situation. Austerity now for stability later may not be such a bad idea. What may work is not profligate Keynesianism, but a toned-down, detail-oriented Keynesianism that is not insensitive to critical long-run considerations.
by C. Jayant Praharaj