Monday, 30 May 2011

False logic from Krugman.

Krugman pointed correctly yesterday to the persistent and unnecessary level of unemployment in the US. He correctly identifies the root cause: indebted households. (On which topic, see this from Seven Keen.) Krugman then goes off the rails by advocating thee highly inappropriate cures, as follows.

1. W.P.A. type programs. 2. Help for underwater households. 3. Raise inflation to 4% so as to reduce the real burden of debt.

The flaws in the above three items are thus.

Re W.P.A. schemes, it is nonsense to boost employment in a narrow range of economic activities (W.P.A. type road and bridge building) just because unemployment is high. If unemployment is unnecessarily high, then ALL types of employment need boosting, don’t they?

As for the idea that W.P.A. type schemes can boost employment without boosting inflation as much as regular employment, that argument is badly flawed. See heading “The Flaws in WPA” here.

2. Re help for underwater households, why do those who have acted responsibly have to subsidise the irresponsible? This is just falling for moral hazard: that is, if it becomes traditional to bail out irresponsible households (or banks, come to that), that just encourages irresponsible behaviour in future.

3. Re raising inflation so as to reduce the burden of debt, that is next to useless for those on variable rate mortgages. That is, interest rates would just rise to take account of inflation.

As to so called “fixed rate” mortgages, increased inflation certainly wouldn’t work in the UK because, despite those adverts you see for so called “fixed rate mortgages”, there is really no such thing. That is, the maximum term of these so called fixed rates is around five years. Presumably the situation in the US is not much different.

Moreover, artificially boosting inflation (in as far as this cure works) is, again, to reward irresponsible behaviour.

So what is the best cure? Well it’s obvious: if there is a lack of demand, then enable the ultimate source of all demand (i.e. households) to “demand” more goods and services. That is, channel new money to Main Street rather than Wall Street.

But people never like obvious cures. As Abba Lerner said, “Fundamentally, the new theory, like all important discoveries, is extremely simple. Indeed, it is this simplicity that makes the public think it is too slick.” And economists don’t like simple cures for economic problems: that puts economists out of work.

Rodger Mitchell did a post on peoples’ refusal to consider simple cures for problems.



  1. Economists have no more predictive abilities than Mystic Meg. And for the same reasons - the models are inapplicable in the real world.

    Just like Mystic Meg, they don't want scientific analysis and they certainly don't want simplicity.

    "Presumably the situation in the US is not much different."

    It is. They have Fannie and Freddie which offer the US mortgage customers 25 and 30 year fixed mortgages with no lock in. These is government backed funding essentially under an 'understanding'.

    So a US mortgagee can remortage to a lower rate fixed for the term of their mortgage whenever Fannie and Freddie offer such a thing.

    Interestingly as the US housing bubble reached its peak, more and more people there opted for the variable rate mortgages - as the fixed rate mortgages were too expensive for people on such limited means.

  2. Ralph,

    You have a mistaken idea of what the WPA really did. It not only built roads, bridges and parks, but it also paid artists, writers, actors -- to do public work. It included paying writers to write (think Steinbeck, Salinger and John Cheever.) You also have to realize that the WPA DID NOT pay minimum wage. It paid the median wage for the occupation they were being hired for. But they did not work full time at that job -- work was typically 1/4 to 1/2 time ranging upto 3/4 time. People on the WPA projects could work on other income producing projects, and were not penalized for working on other things -- this is quite opposed to say the philosophy of UI, where you are actually penalized for working while on UI. Look at the history of the WPA and its various projects e.g. the Federal Writers' Project

  3. Neil, Do you know of any sort of easy guide to what Freddie and Fannie did or do? I can’t find anything. In any event, the name Fannie seems very appropriate :)

    Clonal, Granted the WPA did no consist of EXCLUSIVELY of construction work. But according to the source below, about two thirds was (depending on exactly what you count as “construction”). And that is about ten times the proportion of GDP taken by construction in the “normal” economy. I.e. it’s the unrepresentative nature of WPA work that I was objecting to.

  4. Ralph,

    The New WPA does not have to be a complete copy of the old one. It has to reflect the capabilities of the unemployed. The Federal Writer's Project was a recognition of that. The new WPA would also have to be cognizant of that. But of course, to be really useful, any WPA type project would have to be involved in Public Projects that have a usefulness to society, and on that builds for the future, even though as Keynes' remarked

    "The government should pay people to dig holes in the ground and then fill them up."

    People would reply. "that's stupid, why not pay people to build roads and schools"

    Keynes would respond saying "Fine, pay them to build schools. The point is it doesn't matter what they do as long as the government is creating jobs".
    End Quote

    It should also be noted, that the oft stated observation that the WPA had no effect on unemployment in the US is incorrect. It so happens, that the statisticians compiling the unemployment data series chose to consider the people working for the WPA as still being "unemployed" and footnoted this. However, most economists working with the series chose to ignore the footnote. Event thought this fact was pointed out in the early 70's -- the wrong figures are used to make it appear that work projects do not reduce unemployment.

  5. The ELR seems crazy until you think about effective demand.

    This quote:

    "Keynes would respond saying "Fine, pay them to build schools. The point is it doesn't matter what they do as long as the government is creating jobs". "

    I think people are way to worried about waste for these programs. The point is not to get stuff done for the govt. but rather to get money into peoples hands so they can then make their own decisions.

  6. Clonal and traderscrucible, I half agree with you. That is, I think Keynes was right to say that relatively unproductive work or even totally pointless work (funded by a government deficit) brings benefits in that those so employed spend their newly acquired income, which in turn employs others (in more productive types of work). But I’m sceptical of the merits of creating such unproductive work: that is, why not just boost the incomes of those already in employment? The effect is the same: the extra income gets spent, which employs a portion of the unemployed.

    Warren Mosler ( has long advocated a payroll tax reduction as a means of effecting the latter policy. I agree with him.

    Having said I’m sceptical about creating unproductive work, I actually think there is a small niche for this sort of work. But I think it should take the form of subsidised jobs with existing or regular employers, rather than WPA type schemes. My reasons are here:

  7. Ralph,

    To understand the scope of the 1930's program, see The WPA that Built America is Needed Once Again and Getting America Back to Work Remains the Singular Challenge for the Obama Administration

    On the anniversary of the inauguration of the Works Progress Administration (WPA), it is striking to compare the unemployment record of Franklin Delano Roosevelt, and that of his modern day successor, Barack Obama. FDR’s achievements in putting Americans back to work are among the most impressive of his tenure; he took the rate from 25% to 9.6% by 1936. But so far, Obama’s policies have failed to “jump-start” unemployment in a significant way, even as Wall Street has continued a recovery utterly and totally divorced from Main Street.
    Part of the aversion toward embracing WPA-style programs today is the false idea that they did little to reduce unemployment, which some claim was only “solved” by the war. Most statistical studies understate the effect of the New Deal job creation measures because they don’t show how much of the decline in official employment was attributable to the multiplier effect of spending on direct job creation. Additionally, the “work relief” category does not include employment on public works funded by the Public Works Administration (PWA), nor the multiplier effect of PWA spending. The figures tell the story indirectly, however, in the path official unemployment followed — steeply declining in periods when work relief spending was high and either declining more slowly or increasing in periods when work relief spending was cut back*.

    Estimates for the years prior to 1940 are intended to measure the number of persons who are totally unemployed, having no work at all. For the 1930s this concept, however, does include one large group of persons who had both work and income from work — those on emergency work. In the United States we are concerned with measuring lack of regular work and do not minimize the total by excluding persons with made work or emergency jobs. This contrasts sharply, for example, with the German practice during the 1930s when persons in the labor-force camps were classed as employed, and Soviet practice which includes employment in labor camps, if it includes it at all, as employment. Counting the WPA programs, FDR’s record on unemployment, notably in his first time of office, was formidable, as he took the rate down from 25% to 9.6% by 1936.


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