In the current issue of the New York Review of Books, Paul Krugman and Robin Wells write about the way to end the current slowdown in the US economy. They argue in favor of a huge new stimulus of deficit spending. They do want another half-hearted stimulus like the first obama stimulus bill. Instead, they argue for a stimulus large enough to bring the US to full employment. While they do not put numbers on what they propose, it would seem that they want the government to spend at least another three trillion dollars per year in stimulus spending.
Krugman and his sidekick also address the expected objection that all of the spending will lead to massive deficits which in turn will cause a rise of interest rates and a decline of the dollars. According to Krugman, there will be no increase in interest rates. Private borrowers have left the market and the household savings rate has risen, so the increased savings and additionally available funds will more than cover the cost of the new stimulus. If this leads to a decline in the dollar, it will also help the economy as exports become cheaper and more competative. Krugman also argues in favor of massive quantitative easing by the Fed through the purchase of long term treasury bonds to drive down long term interest rates to 2% or so.
Whew! Where to begin? First, let's looks at the Fed and its buying trillions of dollars of long term treasuries. No matter what name krugman or anyone else tries to give it, this is monetizing the debt. That's right, the Fed buys three tillion dollars of bonds with funds that it just prints. This injects an additional three trillion dollars into the money supply, funds that will be there when the economy recovers. Of course, at that point, it will be too late to get them out and the result will be hyper inflation. Alternatively, the Fed could sell its trillions of dollars of bonds at that point and drive interest rates up to historic highs. That would slow the inflation, but it also could send us back into a severe recession.
Another issue with the Fed buying all of these bonds is that it would become rather obvious in short order what the Fed was doing. That would mean that many current holders of treasury securities would sell them as the Fed bought. Imagine China realizing that its return on the trillion dollars of treasuries that it holds was going down by about half. Logically, the Chinese would reduce their holdings once they felt that the treasury values had risen to the highest likely area. so what would that do? Imagine the Chinese with a trillion dollars in cash rather than in treasury bonds. they would put that money somewhere. In US assets? We would be selling off a big chunk of the productive assets of the country in that case. In stock and corporate bonds? Again, it would drive prices up but control would move to China.
The massive stimulus that krugman advocates is never described by him. Would it be more payoffs to unions and academics? would it actually be items that might stimulate growth? For Krugman, that seems to be a detail that does not even merit discussion.
the truth about Krugman's view, however, is this. If the USA were to spend ten trillion dollars extra over the next three years while at the same time having the Fed pump extra trillions into the money supply, the result would either be the end of the US economy in a firestorm of inflation and depression or, possibly, the recovery that Krugman expects. Sadly, however, economic theory predicts the death of the economy, not recovery. I guess the best analogy is this: if someone with congestive heart failure wants to, he can try curing himself with electroshock therapy on the theory that all that voltage will shock his heart back into good condition. Indeed, there even may be a wacky nobel laureate who speaks favorably about the prospects of such therapy. Unfortunately, nearly the entire medical community agrees that the result of that therapy will be sudden death. What should the patient chose?
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