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.

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