The U.S. Needs an Emergency Jobs Program

In his November 30, 2009 New York Times editorial "The Jobs Imperative," Nobel laureate Paul Krugman argues for an emergency jobs program to reduce the relatively large level of unemployment:

If you’re looking for a job right now, your prospects are terrible. There are six times as many Americans seeking work as there are job openings, and the average duration of unemployment — the time the average job-seeker has spent looking for work — is more than six months, the highest level since the 1930s.

You might think, then, that doing something about the employment situation would be a top policy priority. But now that total financial collapse has been averted, all the urgency seems to have vanished from policy discussion, replaced by a strange passivity. There’s a pervasive sense in Washington that nothing more can or should be done, that we should just wait for the economic recovery to trickle down to workers.

This is wrong and unacceptable.

Yes, the recession is probably over in a technical sense, but that doesn’t mean that full employment is just around the corner. Historically, financial crises have typically been followed not just by severe recessions but by anemic recoveries; it’s usually years before unemployment declines to anything like normal levels. And all indications are that the aftermath of the latest financial crisis is following the usual script. The Federal Reserve, for example, expects unemployment, currently 10.2 percent, to stay above 8 percent — a number that would have been considered disastrous not long ago — until sometime in 2012.

And the damage from sustained high unemployment will last much longer. The long-term unemployed can lose their skills, and even when the economy recovers they tend to have difficulty finding a job, because they’re regarded as poor risks by potential employers. Meanwhile, students who graduate into a poor labor market start their careers at a huge disadvantage — and pay a price in lower earnings for their whole working lives. Failure to act on unemployment isn’t just cruel, it’s short-sighted.

So it’s time for an emergency jobs program.

How is a jobs program different from a second stimulus? It’s a matter of priorities. The 2009 Obama stimulus bill was focused on restoring economic growth. It was, in effect, based on the belief that if you build G.D.P., the jobs will come. That strategy might have worked if the stimulus had been big enough — but it wasn’t. And as a matter of political reality, it’s hard to see how the administration could pass a second stimulus big enough to make up for the original shortfall.

So our best hope now is for a somewhat cheaper program that generates more jobs for the buck. Such a program should shy away from measures, like general tax cuts, that at best lead only indirectly to job creation, with many possible disconnects along the way. Instead, it should consist of measures that more or less directly save or add jobs.

One such measure would be another round of aid to beleaguered state and local governments, which have seen their tax receipts plunge and which, unlike the federal government, can’t borrow to cover a temporary shortfall. More aid would help avoid both a drastic worsening of public services (especially education) and the elimination of hundreds of thousands of jobs.

Meanwhile, the federal government could provide jobs by ... providing jobs. It’s time for at least a small-scale version of the New Deal’s Works Progress Administration, one that would offer relatively low-paying (but much better than nothing) public-service employment. There would be accusations that the government was creating make-work jobs, but the W.P.A. left many solid achievements in its wake. And the key point is that direct public employment can create a lot of jobs at relatively low cost. In a proposal to be released today, the Economic Policy Institute, a progressive think tank, argues that spending $40 billion a year for three years on public-service employment would create a million jobs, which sounds about right.

Finally, we can offer businesses direct incentives for employment. It’s probably too late for a job-conserving program, like the highly successful subsidy Germany offered to employers who maintained their work forces. But employers could be encouraged to add workers as the economy expands. The Economic Policy Institute proposes a tax credit for employers who increase their payrolls, which is certainly worth trying.

All of this would cost money, probably several hundred billion dollars, and raise the budget deficit in the short run. But this has to be weighed against the high cost of inaction in the face of a social and economic emergency.

Later this week, President Obama will hold a “jobs summit.” Most of the people I talk to are cynical about the event, and expect the administration to offer no more than symbolic gestures. But it doesn’t have to be that way. Yes, we can create more jobs — and yes, we should.

Paranoia threatens to emasculate U.S. policy makers

In his November 9, 2009 editorial "Paranoia Strikes Deep," Paul Krugman says the paranoia that is evident in modern politics has existed for a while. The problem is that it is now mainstream and has the potential to inhibit the ability of U.S. policy makers to address social problems.

Last Thursday there was a rally outside the U.S. Capitol to protest pending health care legislation, featuring the kinds of things we’ve grown accustomed to, including large signs showing piles of bodies at Dachau with the caption “National Socialist Healthcare.” It was grotesque — and it was also ominous. For what we may be seeing is America starting to be Californiafied.

The key thing to understand about that rally is that it wasn’t a fringe event. It was sponsored by the House Republican leadership — in fact, it was officially billed as a G.O.P. press conference. Senior lawmakers were in attendance, and apparently had no problem with the tone of the proceedings.

True, Eric Cantor, the second-ranking House Republican, offered some mild criticism after the fact. But the operative word is “mild.” The signs were “inappropriate,” said his spokesman, and the use of Hitler comparisons by such people as Rush Limbaugh, said Mr. Cantor, “conjures up images that frankly are not, I think, very helpful.”

What all this shows is that the G.O.P. has been taken over by the people it used to exploit.

The state of mind visible at recent right-wing demonstrations is nothing new. Back in 1964 the historian Richard Hofstadter published an essay titled, “The Paranoid Style in American Politics,” which reads as if it were based on today’s headlines: Americans on the far right, he wrote, feel that “America has been largely taken away from them and their kind, though they are determined to try to repossess it and to prevent the final destructive act of subversion.” Sound familiar?

But while the paranoid style isn’t new, its role within the G.O.P. is.

When Hofstadter wrote, the right wing felt dispossessed because it was rejected by both major parties. That changed with the rise of Ronald Reagan: Republican politicians began to win elections in part by catering to the passions of the angry right.

Until recently, however, that catering mostly took the form of empty symbolism. Once elections were won, the issues that fired up the base almost always took a back seat to the economic concerns of the elite. Thus in 2004 George W. Bush ran on antiterrorism and “values,” only to announce, as soon as the election was behind him, that his first priority was changing Social Security.

But something snapped last year. Conservatives had long believed that history was on their side, so the G.O.P. establishment could, in effect, urge hard-right activists to wait just a little longer: once the party consolidated its hold on power, they’d get what they wanted. After the Democratic sweep, however, extremists could no longer be fobbed off with promises of future glory.

Furthermore, the loss of both Congress and the White House left a power vacuum in a party accustomed to top-down management. At this point Newt Gingrich is what passes for a sober, reasonable elder statesman of the G.O.P. And he has no authority: Republican voters ignored his call to support a relatively moderate, electable candidate in New York’s special Congressional election.

Real power in the party rests, instead, with the likes of Rush Limbaugh, Glenn Beck and Sarah Palin (who at this point is more a media figure than a conventional politician). Because these people aren’t interested in actually governing, they feed the base’s frenzy instead of trying to curb or channel it. So all the old restraints are gone.

In the short run, this may help Democrats, as it did in that New York race. But maybe not: elections aren’t necessarily won by the candidate with the most rational argument. They’re often determined, instead, by events and economic conditions.

In fact, the party of Limbaugh and Beck could well make major gains in the midterm elections. The Obama administration’s job-creation efforts have fallen short, so that unemployment is likely to stay disastrously high through next year and beyond. The banker-friendly bailout of Wall Street has angered voters, and might even let Republicans claim the mantle of economic populism. Conservatives may not have better ideas, but voters might support them out of sheer frustration.

And if Tea Party Republicans do win big next year, what has already happened in California could happen at the national level. In California, the G.O.P. has essentially shrunk down to a rump party with no interest in actually governing — but that rump remains big enough to prevent anyone else from dealing with the state’s fiscal crisis. If this happens to America as a whole, as it all too easily could, the country could become effectively ungovernable in the midst of an ongoing economic disaster.

The point is that the takeover of the Republican Party by the irrational right is no laughing matter. Something unprecedented is happening here — and it’s very bad for America.

Income Inequality Is At An All-Time High

"In 2007 the top .01 percent of American earners took home 6 percent of total U.S. wages, a figure that has nearly doubled since 2000."

The August 14, 2009 article "Income Inequality Is At An All-Time High: STUDY" on The Huffington Post reports:

Income inequality in the United States is at an all-time high, surpassing even levels seen during the Great Depression, according to a recently updated paper by University of California, Berkeley Professor Emmanuel Saez. The paper, which covers data through 2007, points to a staggering, unprecedented disparity in American incomes. On his blog, Nobel prize-winning economist and New York Times columnist Paul Krugman called the numbers "truly amazing."

Though income inequality has been growing for some time, the paper paints a stark, disturbing portrait of wealth distribution in America. Saez calculates that in 2007 the top .01 percent of American earners took home 6 percent of total U.S. wages, a figure that has nearly doubled since 2000.

As of 2007, the top decile of American earners, Saez writes, pulled in 49.7 percent of total wages, a level that's "higher than any other year since 1917 and even surpasses 1928, the peak of stock market bubble in the 'roaring" 1920s.'"

Beginning in the economic expansion of the early 1990s, Saez argues, the economy began to favor the top tiers American earners, but much of the country missed was left behind. "The top 1 percent incomes captured half of the overall economic growth over the period 1993-2007," Saes writes.

Despite a rising stock market, largely growing employment and a historic housing boom things were not nearly so rosy for the rest of U.S. workers. This trend, according to Saez, only accelerated during the George W. Bush's tenure as President:

"...while the bottom 99 percent of incomes grew at a solid pace of 2.7 percent per year from 1993-2000, these incomes grew only 1.3 percent per year from 2002-2007. As a result, in the economic expansion of 2002-2007, the top 1 percent captured two thirds of income growth."

How did we avert a second Great Depression? The answer, basically, is Big Government.

In his August 10, 2009 op-ed column "Averting the Worst" Paul Krugman explains how government spending has prevented the economic decline from being worse. Recessions and depressions are caused by insufficient overall spending on newly produced goods and services. The collapse of housing prices and the resultant reluctance of banks to extend new loans reduced the demand for new products, leading to reduced purchases and increases in unemployment. Without the government spending, aggregate demand would have fallen even further, making the economic decline much deeper. According to Krugman:

So it seems that we aren’t going to have a second Great Depression after all. What saved us? The answer, basically, is Big Government.

Just to be clear: the economic situation remains terrible, indeed worse than almost anyone thought possible not long ago. The nation has lost 6.7 million jobs since the recession began. Once you take into account the need to find employment for a growing working-age population, we’re probably around nine million jobs short of where we should be.

And the job market still hasn’t turned around — that slight dip in the measured unemployment rate last month was probably a statistical fluke. We haven’t yet reached the point at which things are actually improving; for now, all we have to celebrate are indications that things are getting worse more slowly.

For all that, however, the latest flurry of economic reports suggests that the economy has backed up several paces from the edge of the abyss.

A few months ago the possibility of falling into the abyss seemed all too real. The financial panic of late 2008 was as severe, in some ways, as the banking panic of the early 1930s, and for a while key economic indicators — world trade, world industrial production, even stock prices — were falling as fast as or faster than they did in 1929-30.

But in the 1930s the trend lines just kept heading down. This time, the plunge appears to be ending after just one terrible year.

So what saved us from a full replay of the Great Depression? The answer, almost surely, lies in the very different role played by government.

Probably the most important aspect of the government’s role in this crisis isn’t what it has done, but what it hasn’t done: unlike the private sector, the federal government hasn’t slashed spending as its income has fallen. (State and local governments are a different story.) Tax receipts are way down, but Social Security checks are still going out; Medicare is still covering hospital bills; federal employees, from judges to park rangers to soldiers, are still being paid.

All of this has helped support the economy in its time of need, in a way that didn’t happen back in 1930, when federal spending was a much smaller percentage of G.D.P. And yes, this means that budget deficits — which are a bad thing in normal times — are actually a good thing right now.

In addition to having this “automatic” stabilizing effect, the government has stepped in to rescue the financial sector. You can argue (and I would) that the bailouts of financial firms could and should have been handled better, that taxpayers have paid too much and received too little. Yet it’s possible to be dissatisfied, even angry, about the way the financial bailouts have worked while acknowledging that without these bailouts things would have been much worse.

The point is that this time, unlike in the 1930s, the government didn’t take a hands-off attitude while much of the banking system collapsed. And that’s another reason we’re not living through Great Depression II.

Last and probably least, but by no means trivial, have been the deliberate efforts of the government to pump up the economy. From the beginning, I argued that the American Recovery and Reinvestment Act, a k a the Obama stimulus plan, was too small. Nonetheless, reasonable estimates suggest that around a million more Americans are working now than would have been employed without that plan — a number that will grow over time — and that the stimulus has played a significant role in pulling the economy out of its free fall.

All in all, then, the government has played a crucial stabilizing role in this economic crisis. Ronald Reagan was wrong: sometimes the private sector is the problem, and government is the solution.

And aren’t you glad that right now the government is being run by people who don’t hate government?

We don’t know what the economic policies of a McCain-Palin administration would have been. We do know, however, what Republicans in opposition have been saying — and it boils down to demanding that the government stop standing in the way of a possible depression.

I’m not just talking about opposition to the stimulus. Leading Republicans want to do away with automatic stabilizers, too. Back in March, John Boehner, the House minority leader, declared that since families were suffering, "it’s time for government to tighten their belts and show the American people that we ‘get’ it." Fortunately, his advice was ignored.

I’m still very worried about the economy. There’s still, I fear, a substantial chance that unemployment will remain high for a very long time. But we appear to have averted the worst: utter catastrophe no longer seems likely.

And Big Government, run by people who understand its virtues, is the reason why.

How to Lie with Statistics

"Someone once said about partisan analysts that they use economic data the way a drunkard uses a lamppost: for support rather than illumination. Or as Disraeli put it, there are three kinds of lies: lies, damn lies, and statistics." - Paul Krugman, Peddling Prosperity: Economic Sense and Nonsense in the Age of Diminished Expectations, page 111.

Peddling Prosperity: Economic Sense and Nonsense in the Age of Diminished Expectations by Paul Krugman

This book is essential reading if you want to understand how politics led the U.S. into misguided economic policies.

Information about the book from Amazon.com:

Editorial Reviews

Review
In ten lively chapters, Krugman traces how loose economic thinking has repeatedly led to wrongheaded government policies. In the process, he offers the best primer around on recent US economic history. -- Newsweek 

Product Description
The past twenty years have been an era of economic disappointment in the U.S. They have also been a time of intense economic debate, as rival ideologies contend for policy influence. But strange things have happened to economic ideas on their way to power--they've been hijacked by policy entrepreneurs who offer easy answers to hard problems. 

About the Author
Paul Krugman is the recipient of the 2008 Nobel Prize in Economics. He writes a twice-weekly op-ed column for the New York Times and a blog named for his 2007 book, The Conscience of a Liberal. He teaches economics at Princeton University.

The Convoluted Logic of the Austrian School

Sometimes people should look in the mirror when you they admonish others.

In his November 11, 2008 blog entry "Consumers Don't Cause Recessions," Robert P. Murphy rants against Nobel laureate Paul Krugman and the mainstream of the economics profession. His presumptions and wild leaps of logic are disturbing. For the record, however, here is his post:

There's one saving grace about Paul Krugman's column at the New York Times: when an Austrian economist wants to explain how mainstream economics leads to ruin, he can always trust Krugman to set up the target in a clear, concise manner. This saves us a lot of work, because we don't have to first build up the position before knocking it down.

Even the casual reader of the financial press knows that it is dominated by Keynesian "demand-side" thinking. For example, during the debate over the stimulus checks earlier in the year, the main objection was that taxpayers might use some of their rebate to pay down credit card bills, rather than blowing the whole thing at the mall. But the reader will never see a careful, step-by-step exposition of the worldview that generates such crazy notions.

Enter Paul Krugman. In a recent piece, "When Consumers Capitulate," the newest Nobel laureate spells out the method behind the madness. Let's take the opportunity then to show just why this focus on consumer spending is not only mistaken but downright dangerous.

"The Paradox of Thrift"
Krugman first tells us the (allegedly) bad news: "The long-feared capitulation of American consumers has arrived…[R]eal consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent."

Now let's stop for a moment. Many left-leaning writers—including Krugman—have been warning for years that the US trade deficit was too high, and that the national savings rate was too low. So one would think that a drop in consumer spending would be a good thing. Ah, not so fast: Krugman tells us that "the timing of the new sobriety is deeply unfortunate….For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap."

And now to the actual theory behind all these musings. Krugman writes,

[O]ne of the high points of the semester, if you're a teacher of introductory macroeconomics, comes when you explain how individual virtue can be public vice, how attempts by consumers to do the right thing by saving more can leave everyone worse off. The point is that if consumers cut their spending, and nothing else takes the place of that spending, the economy will slide into a recession, reducing everyone's income.
In fact, consumers' income may actually fall more than their spending, so that their attempt to save more backfires — a possibility known as the paradox of thrift.
My friend Bill Anderson actually derives sustenance from his hatred of Paul Krugman; at lunch one time, Bill skipped a sandwich and instead just bought a New York Times.[1] Now one of Bill's frequent remarks is, "Paul Krugman is not an economist." When I first heard that, I thought Bill was being unfair in order to score a funny point. But the above excerpt from Krugman changes all that.

The most central lesson of economic science—going back further than Adam Smith's "invisible hand" metaphor at least to Mandeville's 1732 Fable of the Bees—is that in a system based on private property, private vices can actually be harnessed for the benefit of the public at large. Specifically, a market economy steers greedy businesspeople into staying up all night, thinking about how best to satisfy their customers.

Besides this truth (discovered relatively recently in human history), people have always known that a wise person refrains from possible consumption in order to accumulate savings. The reason humans in the 21st century are so fantastically wealthy compared to those in the 11th century is not merely a matter of technological innovation. It is also the result of the growing inventories of machines, tools, and equipment (i.e., "capital goods") that have been bequeathed from generation to generation. "Everybody knows" that thrift leads to prosperity, while prodigal spending leads to ruin. There's even a famous story in the Bible on this topic.

It is truly shocking to learn that Krugman not only tells his students the exact opposite—namely that private virtue leads to public vice, and that saving makes the community poorer—but that he actually relishes the demonstration. Fortunately for one's sanity, we can uncover the fallacies pretty easily.

The Misleading "Circular Flow" Model
In a nutshell, the problem with Krugman's Keynesian analysis is that it is static, meaning that it doesn't involve the passage of time, and consequently it can't begin to grapple with the capital structure in a modern economy. The "circular flow diagram" illustrates the way Krugman views the economy:


So during a recession, Krugman thinks that (for some reason) consumers freak out and start spending less. This reduces the revenues earned by firms from the sale of goods and services. But then this means firms have less money with which to hire factors of production (natural resources, labor hours, and capital equipment). That means the income earned by the owners of these items—i.e., everyone in the economy—goes down. But with less income, people in their role as consumers can't spend as much on goods and services, so business receipts fall even further, and so on until the decentralized market economy crashes into a major depression. To repeat, Krugman thinks the free market can't solve this problem, because individuals rationally respond to the onset of the crisis by increasing their cash balances, which only makes the crisis worse.

According to Krugman, in order to escape from this vicious cycle, the government must coax consumers to start spending again, perhaps by cutting interest rates or giving tax refunds. But sometimes (as in the present situation) those remedies are inadequate, and then it is the duty of the politicians to be the adults and spend tens of billions in borrowed money to do a Control-Alt-Delete on the economy.

There are so many problems with Krugman's thinking that it's hard to know where to begin. For starters, if government pump-priming can boost firm revenues, which raises national income, which allows further business expansion, etc. etc., then why employ this technique only during recessions? Why not recommend that the government always engage in deficit spending, in order to create jobs and boost GDP?

"Well," the Keynesian would say, "in a state of full employment, further additions to aggregate demand wouldn't allow firms to hire more workers. The new demand for products and services at that point would serve merely to push up prices, not increase real output."

Ah, now we're getting somewhere. With all the talk of consumer spending and national income, we often forget that actual production must occur before people can consume anything. It doesn't matter how many green pieces of paper are in your wallet; you can't "demand" a TV set unless the store has an actual unit on the shelf. Pushing it back one step, no matter how many customers are lining up outside his store, the manager of Best Buy can't stockpile his shelves with TVs unless the manufacturer has previously assembled them. And of course, the manufacturer can't do so—regardless of how much money he is offered by the Best Buy manager—unless he can find enough workers, and enough of the relevant parts, to actually make the TVs.

We now see why the circular-flow diagram above is a very misleading model of the economy. It leads us to think that output of finished consumer goods can immediately rise and fall with "spending." This framework would hold if there were no capital goods, meaning that all consumer goods and services were produced immediately, as workers took gifts of nature and produced the finished item on the spot.

For example, in an economy composed of masseuses and jugglers, the circular-flow diagram might be useful. If someone wanted a massage and had the cash, the masseuse could go right to work. The only physical constraint on output in the "massage sector" would be the number of masseuses, and the fact that they needed to sleep at some point. Besides the input of the masseuse's labor, the only other item involved is a table, and the same table can be used in the production of thousands of massages before needing to be replaced.

Things are different with most of the goods and services produced in a modern economy. In almost every sector, the workers show up and rely on tools and equipment that greatly magnify their productivity. Moreover, the overwhelming majority of workers don't apply their tools directly to raw natural resources. Instead, they use their tools to transform materials that are shipped to them from other firms.

"There are so many problems with Krugman's thinking that it's hard to know where to begin."
It's useful to take a step back and just consider what happens every day in the worldwide market. There are billions of humans scattered over the planet. Some of us work on oil rigs, pulling up barrels of crude. Some of us work on farms, gathering wheat. Some of us work on oil tankers or drive tractor trailers, bringing the (somewhat) raw materials to others. As consumers, we only see the tail end of a "pipeline" that could be traced back many years. The finished goods you buy at the store are made of components that passed through probably thousands of different hands, in dozens of countries, before all coming together into the item you throw in your grocery cart.

Once we grasp the stunning complexity of the true "economic problem"—how all of this interlocking human activity is coordinated so that production flows smoothly and predictably—we see the absurdity of Keynesian pump-priming remedies. During a recession, it's not as if all output in all sectors falls by the exact same percentage. On the contrary, some sectors shrink more than others. This is because some sectors suffered huge losses, and they need to release some (or all) of their workers and other resources to more profitable sectors. This reshuffling takes time, especially because critical intermediate goods need to be produced so that operations further down the "pipeline" can resume. (In this article, I tell a quick story describing this process for a hypothetical island of 100 people.)

The Keynesians are right that in a condition of "full employment," their proposals won't cause more physical TVs and pickup trucks to roll off the assembly lines. But even in a state of widespread unemployment, the Keynesian solutions don't help. To repeat, this is because we can't simply increase activity in all sectors by, say, 1% to raise output back up to pre-recession levels. Generally speaking, this is physically impossible. No matter how much money consumers or the government throw at it, Ford can produce 1,000 more Rangers only if it can purchase 4,000 more of the appropriate tires. And the tire producer in turn can only meet Ford's request if it can buy the appropriate amount of extra rubber. And the rubber producer can only do this if…and so on.

When the recession is the result of a central-bank-induced artificial boom (such as the recent housing boom), the downturn is a period of readjustment, when misallocated resources are channeled back into more appropriate lines, consistent with consumer preferences and technological realities. When the government steps in and tries to prevent this readjustment, it simply maintains an unsustainable deployment of scarce resources. Bottlenecks occur in the millions of different "pipelines" tracing the flow of natural resources through millions of different workers' hands and onto the store shelves.

There Is Nothing Paradoxical About Thrift
In closing, it will be useful to spell out exactly what happens in a market economy when consumers decide to save more of their income. The first thing to realize is that people do not decide to "spend" or not; rather, they decide whether to spend in the present versus in the future. For example, imagine that thousands of couples in a large city one day decide to skip their weekly restaurant outings in order to save up for a summer cruise. At first, it seems that this would hurt the economy. After all, local restaurants see their sales drop, and so they buy fewer items from their suppliers and lay off some workers. The suppliers and workers in turn have less income to spend, and so sales are hurt elsewhere too.

However, so long as the entrepreneurs involved in the cruise industry anticipate the eventual increase in demand for their services, they will exactly offset the above effects when they hire more workers and other items in preparation for the busy summer months. The new savings (which were previously spent on restaurants) drives down interest rates, perhaps allowing the cruise operators to borrow money and pay for an additional liner. Thus the decision to save more doesn't reduce total income or employment, once everyone adjusts to the new spending patterns. It is really no different from a scenario where thousands of people become health conscious and decide to spend their money on vegetables rather than fast food.

Now it's true, in the present circumstances of our financial panic, consumer spending has fallen because of fear, not because of a fundamental shift in the desired timing of consumption. But still, the point remains that people cut back on present consumption in order to be able to "spend money" in the future. The difference between our present situation and the cruise-liner story above is just that people right now aren't sure exactly when, and on what, they will be spending this extra savings.

Even so, the best solution is still for the government to mind its own business and let people work things out voluntarily. The uncertainty isn't phony; people really don't know what's going to happen next month. In this situation, it is entirely appropriate for humans to stop cranking out so many iPods and designer clothes, allowing a temporary build-up of the resources that go into the production of these nonessential items.

What is especially ironic in all of this is that even on his own terms, Krugman's recommendations make no sense. That is to say, even if we put aside all of the real, physical readjustments that must occur to revamp the economy in light of the unsustainable housing boom, it would still be the case that the government ought to do nothing. If the present crisis really were largely the result of irrational panic and hoarding then government activism would only make people more uncertain about the future. In particular, no one has any idea what Paulson & Bernanke will announce next regarding financial companies and mortgages. If we're trying to reassure consumers that everything is normal, why would we resurrect tools from the New Deal playbook?


$22 $20

There is one more contradiction we should mention. The essence of the paradox of thrift and the liquidity trap is the insight that businesses won't expand operations if there is no demand for their product. But if Krugman and other pump-primers can see that the interruption in spending is only temporary, then so can the business owners involved. And to the extent that it is not temporary—for example, homebuilders are seeing much lower sales, and this isn't simply due to irrational hoarding—then government spending to "fill the gap" only screws things up even more.

For long-run sustainable output, businesses want to have finished products emerging from the pipeline just when consumers want to buy them. Market prices and the profit-and-loss system provide the best means of allowing entrepreneurs to make these forecasts. If the government starts buying, say, office copiers even though it doesn't really need them, that might provide jobs temporarily in a few firms, but the owners know that they can't trust this demand because it is subject to political whim. Thus the government's efforts will simply confuse entrepreneurs who are trying to configure their capacity to meet future demand.

Conclusion
In his discussion of the "paradox of thrift," Paul Krugman proves that he is not an economist—or at least, not a very good one. His policy recommendations are based on a Keynesian model bereft of time and the capital structure of production. Recessions are rooted in misalignments in this unbelievably complex structure, and there needs to be a period of below-normal output as these pipelines are fixed. Most important, consumers are doing the right thing when they increase their saving during a downturn. If solving a recession really were as simple as getting people to spend, then we wouldn't keep experiencing them.