MARKETS

The Nobel-winning economist loves to play the Marley to conservatives’ Scrooge, but it may be he who gets the visit from the ghosts of depressions past, writes MoneyShow.com editor-at-large Howard R. Gold.

Update: An earlier version of this column called it a "liquidity trap" when consumers are saving or paying down debt rather than spending. The correct term is "paradox of thrift," and the text has been changed to reflect that.

He is by far the best-known economist of our time, a Nobel laureate, and a popular columnist for The New York Times.

And he’s the most prominent, unapologetic Keynesian in a profession that until recently had considered the Master of the 1930s passe. But the financial crisis and the Great Recession have given John Maynard Keynes’ ideas new currency, and elevated Paul Krugman to international celebrity.

Still, his certitude and breezy dismissal of dissenting opinions are troubling in a discipline whose aspirations to scientific validity have been shattered in recent years. And Krugman exposes deep problems in Keynesianism through his vast body of writing, including a new book, End This Depression Now!, which sums up his ideas clearly and concisely in a way that’s accessible to a general audience.

I’m approaching this column with some trepidation—Krugman has one more Nobel Prize than I do—but the problems with his thinking have been flagged by others, mainly conservatives. I contacted Krugman and his publicist by e-mail and forwarded some questions but hadn’t heard back by deadline.

Krugman

Can Paul Krugman’s preferred theories work in a peacetime economy? Opinions are sharply divided.

I see three main problems in Krugman’s approach:

  • how much of today’s unemployment is structural
  • whether countries’ long-term debt matters
  • and Keynesian economics’ track record

Krugman believes the financial crisis and Great Recession created an output gap—the difference between the economy’s potential and what it’s currently producing—through a huge shortfall in demand.

Consumers are saving or paying off debt rather than spending. Since consumption represents 70% of the economy, that depresses aggregate demand. Keynesians call it the "paradox of thrift."

With consumption and business investment hobbled, Keynes and Krugman say there’s only one way to fill the gap: The government has to step in with stimulus spending and the Federal Reserve needs an inflationary monetary policy to kick start the economy.

But what if the problem isn’t only a dearth of demand?

Krugman is adamant that current US unemployment is not structural—i.e., that it has deeper causes such as a mismatch of skills between workers and the available jobs. "Structural unemployment is a fake problem, which mainly serves as an excuse for not pursuing real solutions," he wrote. “…All the facts suggest that high unemployment in America is the result of inadequate demand—full stop.”

Actually, economists are divided on this issue—studies by the Chicago and San Francisco Fed support Krugman, while a recent International Monetary Fund paper pegged the structural contribution to long-term US unemployment at 40%. That’s 2 million people…hardly trivial.

And two long-term trends may be suppressing job growth:

  1. Globalization. The US lost 6 million manufacturing jobs from 1998 to 2009, only half of them in the last two recessions. That leaves 3 million. Where did they go? A 2011 report from the liberal Economic Policy Institute said the US trade deficit with China cost 2.8 million US jobs from 2001 to 2010. And in the 2000s US multinationals added almost 2 million jobs in rapidly growing Asia and Latin America while cutting nearly 900,000 in the mature US. How is that caused by a Keynesian output gap?
  2. Housing. The bursting of the housing bubble was the main reason median US household net worth has plunged to its lowest level since 1992. And the number of new housing starts is a fraction of what it was, eliminating housing’s traditional leading role in economic recoveries. With more than 3 million foreclosures so far and over 20% of all US households under water on their mortgages, this problem will linger for years. And gone for good is the $1 to $2 trillion in cash-out refinancing money that hit the economy during the housing bubble.

Continued…

Tickers Mentioned: Tickers: GM, BA