Paul Krugman, a Nobel winning economists, has found himself as the new voice of Keynesianism; a form of economics which supports the idea that government spending indeed helps to lead to economic prosperity. Krugman supposedly has a track record of predicting economic crisis while maintaining his Keynesian mantra. He is a staunch supporter of government spending and has even said on February 2, 2008, that:

“One thing I’ve written about a number of times, but becomes especially worth emphasizing now that John McCain is the presumptive Republican nominee, is the myth of runaway federal spending under the Bush administration… But one thing he thinks he knows is that the Bush administration has been spending like a drunken sailor. Has it?

Consider the actual record of spending. Never mind dollar figures, which grow because of inflation, population growth, and other normal factors. A better guide is spending as a percentage of GDP. And this has increased, from 18.5% in fiscal 2001 to 20% in fiscal 2007.”

He then went on to state on February 19th, 2008, that:

Bush is right about something

Hate to say this, but he’s right when he says

I think actually the spending in the war might help with jobs…because we’re buying equipment, and people are working. I think this economy is down because we built too many houses and the economy’s adjusting.

In fact, I’d say that the sources of the economy’s expansion from 2003 to 2007 were, in order, the housing bubble, the war, and — very much in third place — tax cuts.

Of course, we could have gotten just as much or more stimulus by spending $10 billion a month on actually useful stuff– think how much domestic infrastructure could have been built or repaired for the cost of this miserable war. But the war was what we got.

Clearly there is no contradiction here, but there is an economic fallacy. In Krugman’s first quotation, he stated that we must look at government spending as percentage of GDP, as that would negate inflation. However, according to Milton Friedman and many other economists, government deficits cause inflation when they are financed by creating money. Let’s consider that in the first four years of the Bush administration, interest rates reached as low as 1% on June 25th, 2003 and remained at that level until June 30th, 2004, which means that the Federal Reserve was buying U.S. short term bonds, in essence, creating money. From 2003 to 2004, the U.S. budget deficit was at its highest point until 2008. I’m not sure, but that sounds like it fits the bill for a cause of inflation.

According to Krugman, we should exclude inflation in our statistics of government spending under the Bush (or any other) administration, even though the spending in many ways helped to cause the inflation, as the Federal Reserve would have to up its purchases of short term government bonds to sustain the fiscal stimulus the government was seemingly trying to incur. That may seem pretty illogical, but since it’s from the great Paul Krugman, I think we may have to overlook logic.

In the second quotation, Krugman explains how the economic expansion between 2003 and 2007 were largely a result of government defense spending as opposed to the private industry. Though this is in direct contradiction with the mantra of many Democrats and another Nobel winning economist Joseph Stiglitz, the former council of economic advisers under the Clinton Administration. According to Reuters, Stiglitz has claimed that the Iraqi war was very detrimental to the U.S. economy, and that we are now paying for the consequences. I’m sure that Krugman  threw in his last line, “Of course, we could have gotten just as much or more stimulus by spending $10 billion a month on actually useful stuff,” purely for defense of his own logical reasoning, but does that stand to reason that he is correct?

Admittedly, it is odd that now after the Bush administration has passed, people from Stephen Colbert to Rachel Maddow have insinuated that government spending has a stimulative effect even if it were “war” spending. On the same note, both commentators suggested that the contraction of GDP after the Great Depression was a result of the government spending also contracting. This is true, however it is misleading in that GDP includes government spending. It is not said in their report whether for instance the purchasing power of the economy increased, or if the social welfare actually diminished; I actually wrote the Rachel Maddow show to explain this fact, but alas there was no correction to the “record.” The fact the economist Milton Friedman won a Nobel prize because of his studies of monetary policy and its effect on the depression, as opposed to fiscal policy, has largely become ignored; and the beacon of Keynesian Economics has been brightened by the correct economic insights Paul Krugman. After a simple search though, I came across a paper by Paul Krugman from March 1st of 1992, and it may well make you ponder his competence. The article was titled “A global economy is not the wave of the future,” in which he stated:

“Where is our global economy headed in the 1990s? The most fashionable script says that we are moving into an age of unprecedented international economic integration, that market technology, telecommunications, and faster transportation have shrunk the world, that borders are dissolving, and that we are about to see a globalization of business. …  What I would argue is that we’re heading for regionalization, a breaking up of the world economy into blocs. Twenty years from now, we will consider this period the decline of the second global economy.”

Ironically it was also a Democratic, and sometimes a Republican mantra, that globalism was endangering the U.S. economy, by bringing down wages, some going so far as to say it destroyed the U.S. auto industry. Headlines across the globe in recent months have read that this is a global economic crisis, brought on because of the close ties of each nation’s economy. However, it becomes especially ironic since himself Krugman later went on to write a paper for The Quarterly Journal of Economics entitled “Globalization and the Inequality of Nations,” in 1995, and still another titled “Crises: The Price Of Globalization?” in 2000. Perhaps that’s excusable, it is hard to see too far into the future of economics; but then again, in 2003 he stated that we were in a “liquidity trap,” which of course we weren’t, and in fact the Federal Reserve cut interest rates to alleviate this apparent coming liquidity trap. However by leaving rates at 1% for a little more than a year the Federal Reserve, with its purchases of U.S. government bonds, which’s supply increased pretty handily through government spending, shifted the savings from equity assets to real estate assets. Add on top of that the global economic growth of China, India et al and you had a dosage of inflation in which the CPI Core could never really grasp because it excludes food and energy.

The idea of a “liquidity trap” comes from John Maynard Keynes himself, who predicted that near-zero interest rates could not revive the economy, and that government spending would have to help increase the monetary base. In an article published in the Los Angeles Business Journal, Caroline Baum explains why he and Krugman are wrong, in such a way that I don’t think I myself could without plagiarism, so I will simply quote a portion of the article.

“Krugman, a frequent critic of the Bush administration, warned that the risks of falling into a liquidity-trap “quagmire” were high. Perhaps Krugman should read the speeches of his former Princeton colleague, Fed governor Ben Bernanke. While it’s true that nominal interest rates can’t fall below zero, the thrust of monetary policy isn’t defined by the level of the overnight rate, which is the chosen policy instrument for most central banks. Even when a central bank faces what the Federal Reserve refers to as the “zero-bound policy constraint’ it still has an unlimited ability to print money.

OK, you say. The Fed can print money, but the banks, which get deposits when the central bank buys Treasury securities in the open market, don’t have anyone to lend it. So there is no multiplier effect to energize the Fed’s monetary stimulus.

Wrong. Even when the private sector has no demand for credit, which is hardly the situation today, there is one entity with a voracious appetite: the federal government. With the federal deficit likely to hit $400 billion this year, there’s no lack of government bonds for the Fed to buy.

Nobel laureate Milton Friedman used to tell his students at the University of Chicago that as a theoretical argument, the liquidity trap didn’t make much sense since the central bank can always expand the money stock. When the central bank puts out more money than the public wants to hold, at the margin someone will spend it.

As a practical matter — as an explanation for the Great Depression — Keynes’s liquidity trap didn’t cut it for Friedman either. The Fed allowed the money supply to contract by about a third, which for him was the cause of the protracted period of declining economic growth, wages and profits.”

Despite the denouncement of liquidity traps and economic stimulus as a result of government spending, Paul Krugman has recently argued that we are yet again in a liquidity trap; and yet still, despite his miscues on the economy he was given the Nobel prize in Economics in 2008. It is a wonder that the ideas of government fiscal stimulus, came in a year which government spending expanded globally at an unprecedented rate. While Krugman has recently said that the outlook of the economy looks more promising, the release of government funds due to the “fiscal” stimulus has been minimal, to date spending has been little more than $29 Billion. Of course the Japanese “lost decade” has long been what Krugman and his fellow economist hold onto to prove the lack of government spending can indeed create such a trap, however as this chart illustrates, that’s not exactly true. Sure the stock market is not the economy, but investment is a leading indicator of economic growth, and it does illustrate the spending increase of the Japanese government which had no net effect on their economy.

More Krugman quotes for good measure:

“Economists don’t how to make a poor country rich, or bring back the magic of economic growth when it seems to have gone away.”- Paul Krugman

“Social Security as it is currently constituted is very efficient. We’re talking about a system that really works quite well.” – Paul Krugman

I would guess that if economic growth is slow to recover, the Federal Reserve will enact a policy of “helicopter lending” which is when the Fed would bypass financial intermediaries. While Krugman proposes that we increase government spending, it would advise that we not, seeing as such a thing is hard to unwind and may endanger our nation’s credit rating, putting more pressure on the Federal Reserve to expand the monetary base with purchases of longer debt securities such as the 10 and 30 year t-notes, which could lead to an inflationary storm.

In closing, Krugman has made some positive contributions to economics, but none deserving of a Nobel Prize, or your attention. He wrote his famous book “The Return of Depression Economics,” in 2000….he was 8 years early, and even still he has been horribly wrong and off target. He then gave us the marvel “Conscience of a Liberal,” which is now also the title of his blog for the New York Times, which may indeed be a sign of going off the deep end. I find it horrifying that people are calling for the death of Capitalism, and proposing that Milton Friedman was proven wrong, all while they cite what Time Magazine called one of their top 100 influential people, Paul Krugman.