Up Out of a Macro-Economic Dark Age
Paul Krugman has said we are living in a "Macroëconomic dark ages" where knowledge of the past is "being lost." Specifically he points out how long exploded fallacies are being offered up as deep scholarly truths. To be a classicist for a moment, there was, in fact, a Dark Ages during the Bronze Age when the Greeks lost their knowledge of writing. It was during this post-literate era that Homeric poetry came into being. It was part of a larger transition to the iron age. The fall of Rome hasn’t been the only fall from light.
He repeated those points at the Thinking Big conference yesterday. Which featured a double barreled blast of the case for economic sanity. Highlights included Robert Borosage making a persuasive case that there is no going back to the "old economy" and Larry Mishel laying out how insecurity and broken labor markets have left us at the edge of the precipice. The idea that public good led to higher incomes was something known to "The New Liberalism" of the late 19th century, let alone to the 20th century.
There is empirical evidence from politics of how badly confused the American public is. While as much as 80% of the American public wants some kind of stimulus bill passed, the support for the stimulus bill being placed before them hovers in the mid-fifties. What makes this a sign of an economic dark age is the internals of that number. Only 51% of people in the Gallup poll thought a stimulus bill was "critically" important, and Rasmussen’s tracking poll has support improving but at 44%, still below half of the American public. What’s interesting is that 55% of Americans fear the bill is "too large." The reality is that the stimulus bill, as written right now, is almost certainly too small.
What is going on here is the "family budget fallacy." This is when people look at a national budget, and think as if it is their family budget. They think of family income, which they cannot do much to improve, and think that the country is the same way. Income rains down from someplace else, and if times are bad, the only thing to do is cut, cut, cut, and cut some more. However, this is exactly wrong. A country as a whole has a potential earning power, when output falls well below that number, borrowing to boost it back up increases the total income of the nation. The output that is created would not have happened otherwise.
The breadth of ignorance on this topic is astounding, consider that this factually inaccurate screed is on the first page of a search for "Keynesian Stimulus Theory." In fact, on that page, there is not one even neutral explanation for what, exactly, Keynes proposed. Instead, naked propaganda from people like Dick Morris clutters the page. It’s worse, even, than searches on Darwinian evolution, which is famously cluttered with anti-science zealotry and exploded fallacies.
What Keynes argued is that in a severe enough downturn, people would save more than businesses wanted to invest. While real interest rates would fall, so too would future profits. If the contraction in what he called aggregate demand was sharp enough, it would mean that interest rates would have to be negative to attract enough willingness to borrow. This means that instead of unemployment and savings reducing prices enough to eventually encourage businesses to hire and borrow to invest, the two would reinforce each other: falling prices would mean falling willingness to take risks, which would lead to more unemployment and more fear. Keynes proposed in the 1930’s that a insufficiency of aggregate demand was the problem. To fix this problem, he argued, government would have to borrow and both invest and hire. This would create a stream of future revenue sufficient to make business willing to jump back in. This is the case for Keynesian Stimulus: to get private industry back in the game, to draw water from the well of an advanced economy, some times it was necessary to "prime the pump," a phrase that people who have never had to get water out of a frozen well might not understand these days, to get water flowing again.
Looking ahead we see that failure is a poison tree with many roots. To pick one that is evident now: the cult of "price stability" that gripped economic thought for a generation. In price stability inflation is kept very, very, very low, between 0% and 2%. However, what this has meant for the last decade, is that in the event of a downturn, there was very little room for reducing interest rates, that is monetary policy, and very little ability of governments to work off accumulated debt. Thus, when crisis came, we could not lower interest rates by much, nor are people comfortable adding to debt. In fact, we had to have annual military stimulus and 1% central bank interest rates just to maintain the expansion. It was a Red Queen’s race: we had to run as fast as we could just to stay in place.
What this means, beyond the current crisis, is that long term economic thinking needs to change, and the entire shape of the debate needs to change. What seemed like "safe" business logic of low interest rates, tax cuts, and thinking dominated by prudent budgeting, was, in fact, extremely reckless behavior, chancing that there would never be a downturn bad enough to force the government to slash interest rates and spend heavily. What it also means is something noted at the conference in various ways by almost every speaker at the conference: that public goods are good for the public. We saw the absence of understanding of this essential truth in the stimulus bill fight: many of the provisions stripped out paid for themselves, while many inserted in were almost pure cost and will have little positive effect. It is almost as if people facing a famine decide to beat their plowshares into coins, and hope to buy enough food from someone else.