Monday, November 10, 2008

Krugman, I still don't get it

He offers very sound logic as to why a fiscal stimulus works in the short run:

The economic lesson is the importance of doing enough. FDR thought he was being prudent by reining in his spending plans; in reality, he was taking big risks with the economy and with his legacy. My advice to the Obama people is to figure out how much help they think the economy needs, then add 50 percent. It's much better, in a depressed economy, to err on the side of too much stimulus than on the side of too little.

Now tell me how we're going to muster the political courage to cut government spending and fire people once the economy recovers. Federal spending never decreased in the 20th century, except in the years immediately following the huge spending increases of WWI and WWII.

As a percent of GDP federal spending went from roughly 3% pre-Depression to a peak of 25% in 1982, and declined to 20% during the 90s essentially because GDP outgrew government.

For this very reason, wouldn't tax cuts be a more sensible stimulus? He's a smart guy and he won the Nobel prize so you know he's thought about it. But he just can't bring himself to say it. At least he gives us the converse, that tax increases reduce economic growth:
Well, it wasn't as major as you might think. The effects of federal public works spending were largely offset by other factors, notably a large tax increase, enacted by Herbert Hoover, whose full effects weren't felt until his successor took office. Also, expansionary policy at the federal level was undercut by spending cuts and tax increases at the state and local level.

So why doesn't he simply recommend a tax cut now, particularly a capital gains tax cut, and reduced spending later? This is why I'll never win a Nobel prize.

Alex Tabarrok has more. And Tyler offers some better advice. So does Greg Mankiw.

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