Paul Krugman Proves His Points

Krugman's got reason to be smug. He's right again.

Yes, I'm a fan of Paul Krugman and not simply because he's a liberal, a great writer, and an obviously seasoned teacher. Okay, that's mostly why I like him.

But it's also because he's so often demonstrably right about things. And here with his latest on two economic principles, crowding out and the paradox of thrift, he uses IMF data very convincingly.

The notion of crowding out is a favorite of the right because it's an argument against fiscal stimulus. The right claims that fiscal stimulus is a wash because government spending will simply "crowd out" a similar amount of private spending.

Wrong.

The paradox of thrift is counter-intuitive at first but a no-brainer once you look at it. In an economic downturn we all want to cut back on spending and put aside as much as we can afford for that rainy day we're currently experiencing. The public is deleveraging, or getting out of debt. If too many people do it at once it adds to the problem. As Paul says, my spending is your income and vice versa. If I stop spending, you stop earning. The economy contracts even further, and our ability to continue to save evaporates. Nobody is spending, demand falls, jobs are lost, including maybe ours. Saving is bad. Now we're unemployed and can't save anymore anyway.

So the cure is the disease, and we're screwing ourselves. Hard to break out of a recession that way. The right, once again, likes to say that an economy is like a household and when you're in trouble, stop spending. Deficits will crush you!

That may be true for households, which can suffer tremendously if people overspend their budgets by going into debt. Cars get repossessed and homes get foreclosed on. 2008 anyone?

But the herd acting across an economy will sink itself by overcutting spending. That's the paradox of thrift. It's real and can be devastating. A modest downturn can because a depression if too much money is pulled out of the economy.

Keynesian economics advises the government to take up the slack by increasing spending during downturns, in part to counter the paradox of thrift.

The right says NO! Austerity! Crowding out! But they're wrong, and Krugman's got the goods on that.