Why Paul Krugman and Larry Summers Are Wrong About America Needing Another Mega-Stimulus

 

Here we spend again, I mean, “go” again.

Two of America’s leading liberal economists, Paul Krugman and Larry Summers, want Washington to start spending more—probably much, much more—to boost the sputtering U.S. economy. Extremely low interest rates, they argue, both allow government to borrow cheaply and signal a deep hibernation by bond market vigilantes unconcerned by federal debt levels.

Lots of potential reward with little potential risk—or so Krugman and Summers argue.

Their proposal raises many questions and issues:

1. How much? The 2009 stimulus cost $831 billion, not counting borrowing costs. Without it, according to the Congressional Budget Office, the unemployment rate today would be 0.1 to 0.8 percentage point lower. Using, charitably, the most favorable CBO estimate, we are talking about $100 billion per tenth of a percentage point. So how much is enough for Krugman and Summers, $800 billion? $900 billion? $1 trillion? Or is the sky the limit?

2. What would the money be used for? Summers says in his op-ed that it would be “amazing if there were not many public investment projects” that would pay for themselves by “expanding the economy’s capacity or its ability to innovate.”

First, I would like to vet that short list. Second, is a check from Washington the best way to make these supposed projects happen? Third, what happened to Summers’s famous admonition that stimulus should be “timely, targeted, temporary?” These projects would likely take some time to get going. And if you believe the economic forecasts from the Obama White House, the economy is—yet again—approaching a mini-boom: 3% GDP grow this year, 3.0% in 2013, 4.0% in 2014, 4.2 in 2015, 3.9% in 2016, 3.8% in 2017. Now, I don’t place much stock in those predictions from Summers’s old pals on Team Obama, but he just might.

3. Would the bond vigilantes really stay asleep? Krugman and Summers are preternaturally confident that another big step-up in U.S. indebtedness would have no effect on our ability to borrow. That’s a big assumption, argues AEI’s Desmond Lachman: “An important lesson that the U.S. should be drawing from the Greek experience is how mistaken it is to be guided by low market interest rates. Since it might be recalled that as late as 2009, when it should have been obvious to all that Greece’s public finances were on an unsustainable path, the Greek government was able to raise as much long-term money as it liked at a mere 0.2 percentage points above the rate at which Germany could borrow such money. It might also be recalled how quickly markets turned on Greece and how soon a country that had no difficulty in borrowing from the international capital market at unusually favorable terms found itself totally shut out from that very same market.”

And let’s also keep in mind that the last time Summers tried to outsmart financial markets he lost $2 billion for Harvard’s endowment fund.

4. Might not more debt actually hurt long-term U.S. growth? A new paper from Kenneth Rogoff, Carmen Reinhart, and Vincent Reinhart finds that very high debt levels of 90% of GDP are a long-term burden on economic growth that often lasts for two decades or more: “The average high-debt episodes since 1800 last 23 years and are associated with a growth rate more than one percentage point below the rate typical for periods of lower debt levels. That is, after a quarter-century of high debt, income can be 25% lower than it would have been at normal growth rates.”

5. What about taxes? One huge mistake the high-tax EU has made is making nearly half its austerity program come in the form of even higher taxes. Not only should the U.S. not be raising taxes, we should be cutting them. Our corporate tax is so high that cutting it to 25% from 35% might well pay for itself—not to mention boosting business and investor confidence.

The U.S. economy has been malfunctioning since 2006. Shouldn’t it finally be time to address the deep problems of an anti-growth tax code, economy-stifling regulations, and out-of-control spending?

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  1. Profile Photo Member
    @cdor

    These guys think they are so smart, yet the more complex things are, such as our global economy, sometimes the simplest answer is the smartest one. None of this money belongs to them or the politicians. It belongs us, the people. Their first response should always be prudent. The more entangled the smart people get, the more destructive become the unintended consequences. Borrow and spend more now they say, interest rates are so low. What a lying scam. Interest rates are artificially low. They will most certainly raise. Then what? This is a stealth tax on every individual who has lived correctly and saved for their retirement, as every penny borrowed is paid off with newly printed money. Every dollar printed makes every dollar saved worth less. The government can tax income, but they can’t just take our money…unless they borrow and monetize that extra debt. I am a simple guy. Get back to dinner table budgets. Spend what we can afford. Reduce our long term obligations. Utilize our God given energy assets. Stop being Bloomberg nannies. Let us be free individuals.

    • #1
  2. Profile Photo Member
    @JohnMurdoch

    “These projects would likely take some time to get going.”

    Yeah. About that….

    Let’s assume that Obama finds a magic lantern, rubs it three times, and the genie gives him three wishes. One of which he spends on getting massive stimulus legislation through Congress. Today. 

    First, the feds have to send out Requests for Proposals (RFP) for projects. They’ll provide 90 days for responses. They’ll provide another 30 days after that, because nobody will respond in time. 

    They’ll take 90 days to “evaluate” proposals (to allow politicians to grovel before them, in hopes that their pet projects get funded). Then they’ll announce the projects that will be funded.

    But–this being a federal program–they will have to allow time for the public to comment on the proposed projects. That’s 90 days worth of comments and hearings. Then they’ll take another 90 days to “evaluate” the comments (and provide more time for Congressional groveling) before they announce the final awards.

    Then–only then–do the projects actually get put out for bid.

    Continued below…

    • #2
  3. Profile Photo Member
    @JohnMurdoch

    Continued from #2….

    Assuming these are smaller projects (less than $50 million each) you can put the job “on the street”, and get to bids in 60 days. Then the winning bids have another 60 days to “submit” on the job–demonstrating how they’ll actually do what they propose. Then you have to allow 30 days for the engineers to review the submittals before the bid is finally awarded. 

    THEN–assuming the contractor has submitted a perfect (ha!) submittal, you can actually think about buying a shovel, and looking for a piece of ground. 

    Starting today, June 5, 2012, that means that the Krugman-Summers Stimulus would result in a construction worker getting hired on the Friday after Thanksgiving–of 2013.

    And who starts a construction project in November?

    Realistically–assuming magic, pixie dust, engineering faeries, and willing cooperation from a Congress that has to face the public for re-election in five months, the soonest you could have any stimulus on the economy would be the early spring of 2014.

    But if either Krugman or Summers had a clue, they’d already know that. 

    • #3
  4. Profile Photo Coolidge
    @ctlaw

    Modern Keynsianism is what happens when mediocre intellects think they are geniuses.

    Keynes may have been smart enough that, if he were still alive, he would disagree with much of what’s being done in his name.

    • #4
  5. Profile Photo Member
    @JohnMurdoch

    As evidence of my timeline in #2 and #3 above, I should mention that I spent part of this morning wrapping up a Stimulus I project that was deemed “shovel ready” in 2009. The first shovel hit the ground during the 2011 Summer of Recovery, and the job is only wrapping now. 

    I should also mention that this project (and my timeline above) assumes we’re talking about building construction or renovation on a building site that needs no land acquisition or excavation. Anything involving excavation (for example, widening a highway right-of-way) will add years to the length of the project. Anything involving stringing high-voltage transmission lines (shout out to Doug Kimball!) will take even longer. 

    As somebody pointed out yesterday, if President Obama wants to re-create the public works projects of Roosevelt, he’d have a problem. There’s simply no way he’d get the environmental permits for the Grand Coulee Dam. 

    Public works projects as stimulus is a fantasy. It just doesn’t reflect the reality of public works construction. 

    A faster stimulus, and probably a bigger boost to Obama’s re-election, would be declare war and invade Canada.

    • #5
  6. Profile Photo Member
    @JosephEagar

    I don’t understand.  I’m fairly sure our foreign creditors have quietly vetoed any new mega-stimulus behind the scenes.  Regardless, such a stimulus would lead to a general balance of payments (currency+banking+sovereign) crisis fairly quickly, probably within a year.

    I have a hard time believing Summers actually supports this (he’s probably lying), and while Krugman tends to be more unreasonable and populist, he is very smart and I’m surprised he hasn’t wised up to the situation yet.

    • #6
  7. Profile Photo Coolidge
    @ctlaw

    There are more fundamental errors than those John correctly points out.

    To steal from Jonah Goldberg, we are suffering from an economic cliche tyranny.

    Keynesians first hypothesize a simplistic world where the Pharoah opens his treasury to finance pyramid building. They demonstrate that this creates a stimulus. This reasoning then created a cliche that government spending is stimulus. It is not.

    Pharoah’s wealth was tangible wealth (gold) previously  taken out of the economy. It’s reintroduction was an external stimulus. 

    Not only is modern Western government spending contemporaneously (not previously) taken out of the economy, how it is taken out has extreme negative consequences/disincentives.

    • #7
  8. Profile Photo Member
    @JosephEagar

    Yep, Summers is lying; I read his article.  This is the same man who, in 2009, wrote a memo to Obama reporting that the government had run out of things to spend money on, and that stimulating demand via infrastructure wasn’t going to work.  That is still true today; there simply are not enough potential “shovel-ready” investment projects to significantly affect growth in the short run.

    edit: This qutoe from his article is especially funny:

    There is, of course, still the question of whether more borrowing will increase anxiety about a government’s creditworthiness. It should not, as long as the proceeds of borrowing are used either to reduce future spending, or raise future incomes.

    I guarantee that Summers doesn’t but this argument.  He mentioned this line of reasoning in his 2009 memo, but with some doubt that it was true.  Subsequent events conclusively proved it false; for all of 2009 and 2010, the number one concern of U.S. businesses was fiscal and regulatory uncertainty; they assumed the stimulus would lead to higher future tax rates. 

    • #8
  9. Profile Photo Member
    @TheMugwump

    I remember the days when the fix for a broken record was to smack it!  If that didn’t work, you removed it from the player, busted it over your knee, and tossed it in the bin.  Ah, the good old days.  

    • #9
  10. Profile Photo Member
    @HangOn

    Only since 2006?

    I’d put it earlier than that and in no small part because of the bursting of the dot com bubble and the policies following that.

    • #10
  11. Profile Photo Member
    @

    I would love it if Mr Pethokoukis could address what’s been bothering me for a while.  I understand the issue of compounding interest and the debt to a degree, but I wonder if in a way it’s analogous to that old problem of the one grain of rice on the first square of the chessboard, subsequently doubling until it’s roughly 1000 times annual current world rice production.  Is it the same way with money and debt?  We could manage for the first financial squares, but as we progress along the chessboard we are entering unsustainable exponential growth?  I know there are some problems with the analogy, but . . . .

    • #11
  12. Profile Photo Member
    @Gazaker

    Reality and common sense apparently have no room to squeeze into the intellectual elite minds of Summers and Krugman.

    We’re the brokest nation in history (Steyn) yet we should borrow more and more to buy more bullet trains to nowhere? I’m not an economist nor do I play one on TV, but I’m confident that another stimulus is not what we need.

    • #12
  13. Profile Photo Coolidge
    @BrandonShafer

    Project Canadian Bacon!

    John Murdoch: A faster stimulus, and probably a bigger boost to Obama’s re-election, would be declare war and invade Canada. · 1 hour ago

    • #13
  14. Profile Photo Member
    @BlueAnt
    James Pethokoukis: 

    2. What would the money be used for? Summers says in his op-ed that it would be “amazing if there were not many public investment projects” that would pay for themselves by “expanding the economy’s capacity or its ability to innovate.”

    Whoa, whoa, wait a minute.  Hasn’t his fellow traveler Paul Krugman been screeching for years that we have a demand problem, not capital scarcity or lack of confidence or political uncertainty?

    Companies are sitting on tons of cash.  Factories are idling shifts.  Rail traffic is below previous usage levels, and massive cargo ships are empty or underused.

    I have not seen a single economist, column, study, or anything that suggests the US economy has a capacity problem holding it back.  Nor have I seen any infrastructure or “shovel ready project” claim they are here to increase “ability to innovate”, however you measure such a thing.

    How, exactly, is stacking up even more excess capacity going to help the economy now?  Assuming there is a negative feedback loop in place here, how does stacking up more debt, in the face of widespread debt worries, help to stop falling confidence?

    • #14
  15. Profile Photo Member
    @Larry3435

    There is a circumstance where Keynsian economics works.  That is if you put everyone in the world to work busily killing each other (i.e., WWII).  That really does reduce unemployment.  Still, it somehow just doesn’t feel right.

    Under all other circumstances, Keynsian economics fail.  Every time.  And the lefty explanation is always the same — we didn’t do enough of it.  That remains the explanation until the government has grabbed control of 100% of the wealth and is allocating it according to some 5 year plan.  Then the explanation becomes, “Stalin was the wrong guy to put in charge.”

    • #15
  16. Profile Photo Member
    @AIG

    Summers says in his op-ed that it would be “amazing if there were not many public investment projects” that would pay for themselves by “expanding the economy’s capacity or its ability to innovate.”

    So according to Summers there is no such thing as a diminishing return curve for so-called “infrastructure” projects? Considering that the US, in terms of physical infrastructure (ie roads, ports, railroads etc) is ranked by experts as being in the top 2-3 in the world (behind possibly Germany, and some other small city-state like Singapore or Hong Kong), I would think it amazing that there would be many infrastructure projects that would generate any additional benefit.

    Besides all the issues pointed out above by others (the fact that to get any such projects going requires years of per-work), I suspect we have hit the point where we may have negative marginal returns (of course, it would be hard to know given that we generally lack any market signals for physical infrastructure). Some regional exceptions exist, of course, but spending generally goes to politically expedient projects (like HSR or light rail), not economical projects.

    • #16
  17. Profile Photo Member
    @BlueAnt
    James Pethokoukis: 

    3. Would the bond vigilantes really stay asleep? 

    They were never asleep in the first place.  They are wide awake, chugging energy drinks, conducting a marathon session punishing European bonds.

    The interest rates on US debt aren’t low because we suddenly got financially robust.  They are low because the bond guys have to park money somewhere while they short, downgrade, dump, and otherwise trash everything associated with the Euro (and recently China as well). Ironically, right when it lost its AAA rating, US debt became the least bad investment in a world of shaky sovereign debt.

    Once Europe sorts itself out, or crashes and starts the road back to profitability, the bond vigilantes will turn their attention back to their US portfolio… and they won’t like what they see.

    • #17
  18. Profile Photo Member
    @JimIxtian
    James Pethokoukis: Might not more debt actually hurt long-term U.S. growth?

    Isn’t that one of the things that has undermined Japan’s economy? Kazuo Ueda, a former board member at the Bank of Japan argued in a paper last summer that once the structural deficits and debt becomes large enough, there’s little a central bank can do to stimulate growth. Low or zero interest rates won’t do it, nothing will. Basically, they’re out of gimmicks to spur growth and you are mired in stagnation.

    Also, we shouldn’t only be worried about our debt-to-GDP ratio vis-a-vis the Feds, but state, municipal, and foreign debt; 

    USA: GDP: €10.8 tn F Foreign debt: €10.9 tn €35,156 Foreign debt per person 101% Foreign debt to GDP 100% Govt debt to GDP UK: GDP: €1.7 tn Foreign debt: €7.3 tn €117,580 Foreign debt per person 436% Foreign debt to GDP 81% Govt debt to GDP” Japan:GDP: €4.1 tn Foreign debt: €2 tn€15,934 Foreign debt per person50% Foreign debt to GDP233% Govt debt to GDP
    • #18
  19. Profile Photo Contributor
    @JamesPethokoukis

    And as it just so happens, the CBO put out its update econ and budget forecast today, with one scenario so bad their forecasting model breaks down in 2035.

    • #19
  20. Profile Photo Contributor
    @JamesPethokoukis

    I think the danger here is not only the debt but the interest expense. And as rates rise, rolling over all that debt become every more expensive

    Erik Larsen: I would love it if Mr Pethokoukis could address what’s been bothering me for a while.  I understand the issue of compounding interest and the debt to a degree, but I wonder if in a way it’s analogous to that old problem of the one grain of rice on the first square of the chessboard, subsequently doubling until it’s roughly 1000 times annual current world rice production.  Is it the same way with money and debt?  We could manage for the first financial squares, but as we progress along the chessboard we are entering unsustainable exponential growth?  I know there are some problems with the analogy, but . . . . · 4 hours ago

    • #20
  21. Profile Photo Member
    @JosephEagar
    James Pethokoukis: I think the danger here is not only the debt but the interest expense. And as rates rise, rolling over all that debt become every more expensive · 32 minutes ago

    There’s also the danger that foreign investors will cease funding the U.S. current account deficit, triggering the mother of all financial crises.  That’s the real  problem with fiscal stimulus–lower unemployment would be funded by foreign capital, and this time I don’t think foreigners would put up with it.

    Obama basically sealed his fate in 2009 when he chose a stimulus now/structural reform later approach to the economy.  He should have passed structural reforms in 2009 while he still had his mandate, and hope the reforms kicked in before the 2012 election.  Those reforms would have had to been center-right however, which Obama (who came into politics bashing center-right neocon Republicans and centrist neoliberal Democrats) was incapable of doing.

    • #21
  22. Profile Photo Member
    @PaulKline

    What I don’t understand is Krugman’s long term view of this policy.  He now claims the $1 trillion was too little to stimulate the economy.  So we need another $2 trillion?  Hard to say as they don’t seem to give specific numbers (so they can always make the “it wasn’t enough” claim).  His point is that money is cheap now and so there is no downside.  But let’s assume it works and the economy comes roaring back, to the point that we eliminate the annual deficit just from growth (and some healthy taxes on “the rich” which do not impede that growth).  At some point, interest rates come up from almost zero and our payments for debt servicing go through the roof.  Nothing lasts forever including cheap money.  I wish I could get my head around where these guys think we’ll be in the long term.  I get the concept of  “cut now so when interest rates go up, we can afford it.”  I don’t get “spend now, jumpstart the economy and the future will take care of itself.”

    • #22

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