There are few absolutes in this world, but a couple of truisms hold up pretty well:
- Never fight a land war in Asia, and
- Don't disagree with Paul Krugman, he's almost always right.(See, here) and (here.)
The latest news from Iraq and Afghanistan is sufficient to demonstrate the first. The truth of the second was reaffirmed in the last news cycle as well. See, Ron Fournier Attacks Paul Krugman, Embarrasses Self.
So it is not without trepidation that I declare that Paul Krugman is flat wrong in his latest opinion piece, Why Economics Failed:
While it’s true that few economists saw the crisis coming — mainly, I’d argue, because few realized how fragile our deregulated financial system had become, and how vulnerable debt-burdened families were to a plunge in housing prices — the clean little secret of recent years is that, since the fall of Lehman Brothers, basic textbook macroeconomics has performed very well.
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Economists who took their own textbooks seriously quickly diagnosed the nature of our economic malaise: We were suffering from inadequate demand. The financial crisis and the housing bust created an environment in which everyone was trying to spend less, but my spending is your income and your spending is my income, so when everyone tries to cut spending at the same time the result is an overall decline in incomes and a depressed economy. And we know (or should know) that depressed economies behave quite differently from economies that are at or near full employment.
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In particular, this was no time to worry about budget deficits and cut spending, which would only deepen the depression.
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We needed more government spending, not less, to fill the hole left by inadequate private demand.
Notice how small a victory he's claiming here. Economic's great success was in telling policy makers that depressions are caused by inadequate demand and that when no one else is spending money the government needs to step in and spend.
But why bother with economists? Any competent historian can tell you that the Great Depression ended when the Federal Government embarked on the massive program of deficit spending known as "winning World War II".
The second thing to notice is that this policy lesson, whether from history or economics, was, in fact, applied by President Obama. His very first priority in office was the passage of a massive $800 billion dollar stimulus package. "Massive" is a relative term and the package fell far short of WWII levels and ultimately came up short in getting everyone back to work. But despite its flaws, the stimulus worked wonders, as anyone in Spain or the UK can tell you.
So what's the problem? The failure, according to Krugman, was a failure to understand the size and fragility of the shadow-banking sector. Otherwise, textbook economics would have anticipated the events of 2008. This seems... unlikely, but let's leave it for now, because Krugman still has 400 or so words left and he's got another target in mind: the folks who contradicted "textbook economics" and prevented further stimulus. Who are the guilty ones?
Krugman lists bankers, business leaders, John Boehner, and President Obama. How did they defeat the economists?
...John Boehner, then the House minority leader, declared in early 2009 that since American families were having to tighten their belts, the government should tighten its belt, too...
...a few months later President Obama started saying exactly the same thing. In fact, it became a standard line in his speeches.
Really? The greatest minds of economics were defeated by a bad analogy?
Not quite. Krugman points to two additional forces that opposed good economic sense: "well informed people" and "powerful political factions", who used "bad economic analysis" in good faith and bad, respectively.
All of this is a dodge that Krugman employs to avoid stating the obvious: Krugman's "textbook economics" was opposed by lots and lots of economists! In Krugman's usage, "well informed people" is a synonym for "economists at the Universities of Chicago, Minnesota, and Harvard, the European Central Bank and the IMF."
Why the euphemisms? Because without them we see that the true value of "textbook economics" is that it tells us not to listen to other economists! What's a layman to do? Either listen to Paul Krugman, or...
Don't listen to any economists at all! Remember, history is sufficient to provide the lessons of the Great Depression. And the fantastic thing is that you needn't worry if you listen to a "Freshwater" historian or one from a "Saltwater" school: they all say the same thing!
Stepping back, a much more general question needs to be asked, "Do economists ever solve any problems that aren't created by other economists?"
More to come...
Update: We know in retrospect that Krugman was right, the Fed's program of Quantitative Easing did not lead to massive inflation. But at the time, how would we have distinguished between Krugman's "textbook economics" and other academic economists, See, e.g.: Professor Allen Meltzer, Carnegie Mellon University, see, Inflation Nation. The signers of this open letter to Ben Bernanke warning about QE causing inflation including:
Professor John B. Taylor, Stanford University; Professor Michael Boskin, Stanford University; Professor John F. Cogan, Stanford University; Professor Ronald I. MacKinnon, Stanford University; Professor Gregory Hess, Claremont McKenna College.