Mish has a rather damning post for Krugman, where he flags this article of Krugman's from 2002:
Dubya's Double Dip?
The basic point is that the recession of 2001 wasn't a typical postwar slump, brought on when an inflation-fighting Fed raises interest rates and easily ended by a snapback in housing and consumer spending when the Fed brings rates back down again. This was a prewar-style recession, a morning after brought on by irrational exuberance. To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.
Judging by Mr. Greenspan's remarkably cheerful recent testimony, he still thinks he can pull that off.
As we now know, Greenspan did pull it off, and, in the process, just made the problem that much bigger ... which brings us to today, where we have an (even worse) "typical pre-war recession."
Now the question is again whether it makes sense to throw yet more money at the economy to keep it alive, as Krugman (notwithstanding his earlier pessimism) now suggests we do. But there are in fact two different questions there:
- will it work? (this is the point on which Krugman has changed his mind over the past 7 years);
- is it a good thing in the long run? (he's basically saying that we can't afford not to do it, and that we'll deal with later, well, later)
What is agreed by everybody is that there has been a massive collapse of demand, as a brutal process of deleveraging is making (or forcing) people and corporations divert money to pay back their debt and, in a vicious circle, lower demand reduces income for others and further reduces their ability to spend.
Governments have stepped in, directly and indirectly, to try to replace private demand by public demand - and this has been done, to a large extent, via borrowing, thus replacing private borrowing by public borrowing. A lot of the debate is about whether that increase in public borrowing is sustainable.
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The fundamental problem is that consumption funded by debt is not sustainable - and that is true whether debt is public or private, even if it is also probably true that the public sector can get away with it longer than the private sector, and thus a government spending bubble could last a fewmore years.
Governments replacing private, debt-fuelled demand by public, debt-fuelled investment - now, that would be something else. Investment usually means that the debt can be paid off via what the money has been initially spent on, not by further straining the existing productive capacity. Investment in public transport infrastructure, smart grids, energy efficiency in housing, education, healthcare for all - all of these have the potential to sustain a richer economy into the future, and create jobs to get there, just building the new assets.
But government spending to prop up consumption - and worse, government subsidizing the holes made by irresponsible financial corporations (ie, the money will not even be spent, it will just go to lessening the asset losses of investors who should have known better), that will go nowhere fast. Increasingly large amounts of money need to be spent for an ever smaller impact.
During the housing bubble, a period that was touted as one of extraordinary prosperity, most households did not see any increase in their incomes during the boom. The bust speaks for itself. Do we really want to go through a larger scale version of this? Zero income growth will still be zero income growth, and the crash will be even more spectacular.
Krugman was right back in 2002: we are seeing pre_war-type (or, more specifically, *pre-New-Deal-regulation) recessions. The solution to these is not to inflate bubbles that create a temporary illusion of prosperity at a large cost later, it is to do what was done in the 1930s, to the same screams from the corporatists and financiers that we are hearing today: regulate, tax, redistribute, invest in infrastructure.
So, ultimately, today's Krugman is correct, in that governments should not stop their efforts. But he should be more precise: they need to actually start investing in the economy rather than propping up the failed and destructive financial system.