A Keynesian Take on the Debt-Ceiling Deal: Paul Krugman Derides Obama’s Faith in the “Confidence Fairy”

Here’s a small part of what Paul Krugman recently wrote in the New York Times on the debt-ceiling deal:

We currently have a deeply depressed economy. We will almost certainly continue to have a depressed economy all through next year. And we will probably have a depressed economy through 2013 as well, if not beyond.

The worst thing you can do in these circumstances is slash government spending, since that will depress the economy even further. Pay no attention to those who invoke the confidence fairy, claiming that tough action on the budget will reassure businesses and consumers, leading them to spend more. It doesn’t work that way, a fact confirmed by many studies of the historical record.

I think Paul Krugman’s Keynesian take on the debt-ceiling deal is wrong, but he’s a Nobel Prize winning economist and I’m just an English teacher.

My guess is that, through the debt-ceiling deal, Barack Obama has set himself up for reelection rather nicely and that the economy will come back strong by next year. But Paul Krugman’s opinion, given his intelligence and expertise, gives me pause.

But not much. If I were a financial planner, I’d say the following: 

Sell your gold and put it into stocks.

My bet is that President Obama is the new Reagan-Thatcher-Clinton who will happily preside over a new and sustained period of economic expansion.

I think this is President Obama’s bet as well. Rolling the dice with the Friedmanites against the Keynesians is what I’m guessing is in the President’s head.

We’ll know, of course, at the end of next year whether he was right to do so.

As regards to why, exactly, I think Krugman is probably wrong, I would offer one observation: in the above quote of Krugman’s, note its materialist premise. He thinks that the government, by borrowing money and spending it, is a greater engine for economic growth than the mental states of investors, business owners, entrepreneurs, and CEOs. What capitalists think about the national debt is less important, in Krugman’s estimation, than simply bringing consumers into their stores. 

Krugman, in other words, treats capitalists like park pigeons responding, without worry for the future, to an immediate reward of bread crumbs scattered over the ground. To make the argument that the national debt should be lowered to positively impact the long-term psychology of capitalists is to “invoke the confidence fairy.”

But it is the human mind, and it’s ability to anticipate the future, that is the key to sustainable economic growth, not artificially manufactured and temporary demand.

That’s my take, for what it’s worth.

Here’s an old clip of Milton Friedman, an economist of Krugman’s stature, questioning Keynesianism:

About Santi Tafarella

I teach writing and literature at Antelope Valley College in California.
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6 Responses to A Keynesian Take on the Debt-Ceiling Deal: Paul Krugman Derides Obama’s Faith in the “Confidence Fairy”

  1. Cody Deitz says:

    I generally agree with Krugman but I can understand your apprehension. You and Krugman seem to be approaching the same problem from ideologically different places.

    I would pay attention to who creates demand, which is the consumer. If those at the poorest level of the lower class have no money to purchase the cheaply made goods that provide U.S. (and foreign) corporations the fattest profit margin, we won’t see an increase in production on their part. There’s definitely a give and take element at work here. You want to increase the confidence of the consumer, of course, but if the consumer has no money to purchase goods and services, his/her confidence counts for little. I suppose I’m just wary of cuts that could hurt the poorest Americans.

    • santitafarella says:

      Cody,

      In my view, what produces wealth, ultimately, is thought and work. All of life, including economic life, is predicated on fighting entropy (the tendency of things to fall apart and for information to degrade over time).

      Thus, in a slow economy, it makes sense for the government to spend money on obviously useful projects (building needed infrastructure, supporting scientific research, etc).

      But, when it comes right down to it, the way people are going to become wealthier is by productive thought and work.

      To get this, you need willing buyers linked to willing sellers pursuing their own self-interests. People won’t work or think very hard without monetary motivation. So this also means that people have to be free to think, work, and trade with each other.

      What conditions maximize these things and release the human spirit most fully?

      That’s the debate, don’t you think?

      Let’s pretend, for example, that Krugman’s wet dream was realized: a 3 trillion dollar stimulus put on the federal government’s credit card. And let’s say this stimulus was simply distributed equally to the poorest 100 million men, women, and children in America, giving each of them a one-time deposit into their bank accounts of $30,000 dollars.

      What would happen by goosing “consumers” in this way? Would the money be spent well, wisely, justly? Would it cause capitalists to build factories for long term planning?

      My bet is that a great deal of this money would be frittered away, and that rather quickly. Inflation, for example, would probably eat up, on average, at least 1-2 thousand dollars of each person’s stash right off the top (as sellers started testing higher prices for their goods and services). Why, after all, sell 5 cars for $20,000 if you find that you can sell 4 of them for $30,000?

      And think of the resentment of the other 200 million Americans who didn’t get the stimulus, but had to work hard that year just the same.

      Justice is an issue when it comes to who gets what and why.

      And think of those who opt not to seek work at all and just enjoy living on the 30,000 for the year?

      And what might bond traders make of a 3 trillion dollar stimulus? Would they worry about the credit worthiness of the country and would we see interest rates rise? Would the Chinese get pissed that we were devaluing our currency?

      There’s really no substitute for self-interested thought and work based in the free exchange of goods and services with fellow citizens and those internationally, at least in my opinion. Everything else that claims to produce wealth is blue pipe smoke and mirrors.

      What we need (for example) is something new and clever to come out of Silicon Valley. That’s not hope in a “technology fairy.” That’s how wealth really is created—out of the creative minds and creative efforts of free people.

      —Santi

      • Cody Deitz says:

        Yes, I think that is the debate. That’s a fair way of looking at it.

        I agree that “Krugman’s wet dream” of cutting an enormous check for the poorest Americans would probably fail to create genuine, long-term invest and growth. While I mentioned that the economy won’t improve much when the poorest Americans are struggling to pay for their basic needs, I also don’t think showering them with money will help much either. The potential problems with a large stimulus of that nature are legitimate and realistic concerns.

        This goes back to the give and take I was talking about. Of course you want the confidence of the consumer and the capitalist to be augmented. That huge stimulus would provide the poorest consumers with the ability to purchase goods and services, which would create temporary improvement but would fail to generate authentic confidence (and therefore action) of the capitalist. There’s a balance that needs to be struck. We clearly need to make cuts but crippling the poorest of the lower class by slashing the government services they use is the wrong way to go about it. Personally, I would be more than happy to pay additional taxes to help keep those programs afloat while still making the necessary cuts.

  2. Colin Hutton says:

    Santi

    I think the real problem with the Keynesian approach is that you can’t trust politicians with money. They will squander it buying votes in the next upcoming election, rather than investing it in infrastructure, which has a longer-term payback than the next election.

    Using your example :

    Give $30,000 to each of the poorest 100 million Americans and they will spend it on big plasma TVs and big-boys toys from Sears.

    That will get the pollies votes next year, but, in today’s globalised world, will boost China’s manufacturers and economy and do little for the USA economy. The Chinese will increase their savings by $1t, and invest those savings in more US treasuries!

    I’m sure Keynes would not have approved.

    Colin

    • santitafarella says:

      Colin,

      I like your analysis. Keynesianism strikes me as akin to a perpetual motion machine, pretending to move things around while not really producing anything.

      —Santi

      • Colin Hutton says:

        Santi :

        Your take on my comment is revealingly US-centric. Valid within that context, but perhaps missing my global thesis.

        Faced with a recession 50 years ago, Keynes might well have advised your Treasury to provide a stimulus to consumer spending. It would have boosted manufacturing jobs and growth within the US economy.

        However, adapting one of his famous dicta, Keynes might also have said “and when the times change, I will change my advice”.

        In today’s globalised economy, increased spending by US consumers is likely to boost Australian production of coal and iron ore which the Chinese will use to manufacture the stuff they export to Sears which then sells the stuff to US consumers. Not a zero-sum game : Good for US politicians looking for votes next year. Good for Aus and China’s economies. Minimal boost to US economy, bad for its debt problem.

        Incidentally #1 : “……..he’s a Nobel Prize winning economist and I’m just an English teacher”. So ??
        Prompted by a couple of your posts over the past year, I have read various of Krugman’s articles. Pontifications based on the benefit of hindsight.

        Incidentally #2 : otoh stick with the teaching and stay away from the financial planning.

        Colin

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