Newsnight: Krugman v Moulton and Leadsom

I am in New York at present so I did not see the Newsnight confrontation between Paul Krugman, Jon Moulton and Andrea Leadsom MP. But a combination of my blog post on Krugman’s LSE lecture and the Newsnight piece created an unusually large number of comments on my blog so I thought I would post a response now that I have seen the programme on BBC iPlayer. You can view the interview here (starts 31mins in).

Alcuin asked me for my impressions of the debate. I thought that Moulton and Leadsom more than held their own. I hope that Jeremy Paxman’s remarks that you can’t disagree with a Nobel prize winning economist was, as it seemed, tongue-in-cheek. Jon is a very sensible financier. I have not come across Andrea Leadsom before but I agree with DarwenLad - she is one of the few MPs whom I have heard say anything sensible about the financial crisis and depression we are in. I know this - I would rather have the economy, government, and/or my money run by Jon Moulton than I would by Paul Krugman or any other economist.

I found Krugman condescending and dismissive, for example, when Moulton cited Antonio Afonso’s research showing that the size of the state is negatively correlated with economic growth, saying he could disprove it but it would require ‘some equations and charts’. Translation - “I need pictures in order for me to be able to explain this to mere mortals like you”. In my view if you are good, you can explain your arguments and a concept.

Krugman was almost a case study of accusing others of committing the sin he himself could be accused of being guilty of when he accused Moulton and Leadsom of wanting to cut the size of public spending for doctrinaire political reasons and using the crisis as an excuse to do so. Perhaps what has sensitised him to such concealed motivations is that he is a left wing economist who wants to pursue a big state and public spending for social engineering and who distrusts the private sector?

I was disappointed that Krugman was allowed to get away with the assertion that we have experienced two years of austerity already when there has been very little austerity in the sense of cuts in government spending, particularly in the UK, and none at all in places such as the United States.

To answer John Healy no one is engaging with me from government. I have made numerous offers to work with politicians from any party who want to try to fix this situation and my approaches have been universally ignored or rejected. This does not improve my view of the motivation and perspicacity of those in power.

Keith Price I will let you know where I think the cuts should fall. I have already promised to post on this blog on that for an earlier Commenter on my Austerity v Growth piece and will do so.

Ken Charman - what a good idea. You are right. All ministers should be taught a litany which they should deliver at the start of any media interview which spells out the reality of this situation. I would add that any debate on austerity should be preceded by the simple statement “There hasn’t been any yet”.

Dropsopkcin: I don’t have a chart of tax v GDP but since tax is to fund the state I suggest you may get what you want from the study which Jon Moulton was referring to which I believe is by Antonio Afonso and Davide Furceri “Government, Composition, Volatility and Economic Growth” January 2008 available online here. Ironically it’s a European Central Bank research paper!

Comments

[Alcuin]

Thank you very much for this in-depth response to my question. I am not an economist, but I (for my sins) record and watch Hardtalk pretty religiously and find that when talking to conservative economists, Stephen Sackur nearly always comes up with a quote from "Nobel Prize winning economist Paul Krugman" to underline some Leftist narrative he is pushing (appeal to authority fallacy).

Krugman used the analogy of bleeding the patient - the old medical remedy that did have merit in some cases - with respect to the austerity regime supported by most conservative economists and politicians. He seemed oblivious to the obvious charge that such an analogy applied even more to the bleeding of our children's assets to the point of bankruptcy that he advocates.

This sort of accusation of having "ideological reasons" for cutting the size of the state is also much used by Sackur. The converse position, essentially "what is Government for", is not examined - it being an article of faith that the State should effectively function as a womb for the incompetent for life.

I found it interesting that Paxman was mostly silent through the whole exchange. I would love to know what he was thinking. Paxo's "Empire" series was pretty dire, particularly his absurd take on General Gordon, so he suffers from cultural cringe, but where his political leanings lie re the current debate is not quite so obvious.

[Tr pai]

Keep up the good work terry. I find Krugman very condescending and arrogant. He simply doesn't listen to anyone else it seems.

[gm]

I've never read such guff in my life. Paul Krugman, a real economist, slapped down a couple of idiots who think that repeating boring rightwing dogma is somehow an intelligent contribution to a debate aboit real economics! What a couple of tools. What we need for this crisis are people with real brains, and not stupid people who can simply repeat neo liberal mantras in the misaken belief that it has any relevance

[Fouad]

I watched this debate and think that Krugman is mistaken. In order to undermine Molton and Leadsom, he raised the case of Sweden, implying that a large state can be as efficient as a small one, but please note that the country has a lower productivity rate than average (OECD Sweden economic outlook 86). Moreover Sweden has benefited from its very open economy; i.e. Swedish export companies provide more than half of the country's economic output and have contributed disproportionately to tax revenues and state spending.

p.s. strange how economists go off on a tangent and do not compare apples with apples. Ha-Joon Chang who lectures on development economics also cited Sweden recently, to justify some erroneous argument. I hope that he is not following Krugman on twitter!

Thank you.

[Andrew]

Your claim that Krugman has an implied equal and oppposite ideological bias to Leadsom & Moulton is false.

The difference is that Leadsom and Moulton start with an assumption that the State is too big and use that as a rationale for an economic policy that is entirely unsupported either by basic economic theory or by actual data. By contrast, Krugman starts with an economic model that *is* supported by the data and uses that as basis for a policy.

In other words, Leadsom and Moulton have the ideological view: "government spending = bad"; whereas, Krugman has the *economic* view: "government spending = good".

In order for you to prove that Krugman's view was *really* an ideological position, you would have to do one of two things (preferably both):
A. show that Krugman's data and economic model are wrong; AND/OR
B. provide data and an economic model that support the "austerity" policy.

I look forward to your attempt at either.
You already appear to be admitting that you can't do B. because "there's been very little austerity". To which I would make two points:
1. In practice, the third graph on this page: http://bit.ly/J0xZlA says that's false;
2. In theory, austerity is supposed to promote "confidence"...so whether we've *really* tried it or not is irrelevant.

On a more general point, your assertion that Leadsom and Moulton "more than held their own" is laughable. They were completely outgunned: incapable of rebutting a single claim that Krugman made and unable to defend their own position with anything approaching a coherent argument. I particularly enjoyed Leadsom's "it's simple maths!" and Moulton's "Estonia!"

[Terry Smith]

gm: I wonder if you can add some substance-just saying someone's position is wrong or "guff" does not prove it is. 1. Since Mr Krugman failed to enlighten us about what is wrong with Antonio Afonso's research which Jon Moulton cited, about the inverse correlation between the size of the state and economic growth, perhaps you could do so; and 2. Where would you obtain the funding for the additional deficit spending that Krugman advocates?

[Andrew]

OK, I'll bite. On the first question, the reason he dismisses the Afonso remark is because it's a red herring. Krugman is not interested in an ideologically-based debate about whether *in general* "increased government spending = bad" but rather wants to deal with the specifics of the situation we're in right now, i.e. a liquidity trap. The Afonso paper you link to doesn't cover the current financial crisis at all which should be your first clue as to its utility; the second clue is that, although it does cover the period of Japan's "lost decade", Japan's fiscal policy response is not discussed at all.

If you want to understand why the specifics are important, try this paper: http://bit.ly/GOr4FS
Also, if you enjoy looking at correlations between government size vs. growth, try the first graph on this page from Martin Wolf: http://on.ft.com/MaKSci (hint: there's no correlation)

I remind you as well that Krugman has himself said that if the economy were recovering, he would return to being a deficit hawk at the drop of a hat. This is not about ideology, it's about basic economic theory.

On your second question, you might have to rephrase it, I'm afraid. Is there some problem I'm not aware of whereby HM Treasury is struggling to issue debt?

[Terry Smith]

Andrew: We’re not in a ‘liquidity trap’. Our problem is one of solvency which cannot be cured by more liquidity. If it could be cured by liquidity, it already would have been, after all there’s been plenty provided.

What Krugman said he would do if there was a recovery is of less interest to me than the actions of those who were in power and profess agreement with him such as the Labour Government which ran an increasing deficit from 2002-during an economic boom. Actions speak louder than words.

With regard to my second question, I don’t think I need to rephrase it. If the government is finding it so easy to borrow, why does it own about a third of its own bonds? The low interest rate on government debt in certain countries like the UK is a result of a combination of factors: 1. Quantitative Easing-if you buy your own bonds you are setting the marginal interest rate-as a great man once said “When a man debates with himself, it rarely results in a bar room brawl”. The government is hardly going to pay a rate to itself which sets its cost of debt at a level which external creditors might require to purchase those bonds; 2. Financial Repression-investors and institutions are being driven to buy government debt by regulation-take a look at the risk weighting of sovereign debt in banks capital adequacy ratios versus that on corporate bonds or equities; 3. Their perceived safe haven status in contrast to the train wreck occurring in the Eurozone, which exemplifies the case against your arguments; and 4. The rhetoric which the UK coalition government is spouting about austerity which is mollifying the markets in much the same way as some people might be fooled about statements about Krugman’s future fiscal hawkishness in the more than unlikely event that his policy suggestions produced a recovery. It would be an interesting experiment for the UK government to publicly abandon its stated commitment to deficit reduction and see what happened to the cost of borrowing from the bond market. I can predict the outcome and would be happy to observe it from a safe distance.

You and Mr Krugman don’t like the conclusions of Antonio Afonso’s research and so choose to dismiss it as irrelevant to this situation, but what about: 1.The 2011 paper by Davide Furceri and Ricardo Sousa who studied 145 countries over 47-years and found that every one per cent of GDP rise in government spending reduces private consumption and private investment by 1.9 per cent; 2. The 2008 study by Asa Johansson and colleagues of 21 OECD countries over a 35-year period found that every one per cent rise in tax as a share of GDP is associated with a 0.14-0.27 per cent fall in GDP; and 3. The 2009 study of 15 EU member states by Mihai Mutascu and Marius Milos which found that the optimal public spending share of GDP was 30 per cent? Public spending in the UK is close to half of GDP today. I agree about the need for stimulus, but that can only be provided by cutting back the size of state spending and then cutting taxes.

I regard the growth versus austerity debate as interesting but futile. We are going to get austerity whether you or other people vote for it or not. All that remains to be decided is whether it will be self imposed or whether it will be the result of externally dictated terms. The only reason I argue against Krugman’s and your stance is that by convincing some people that there is a relatively painless route out of this predicament you raise false hopes and do them a dis-service.

[Chris]

I thought Krugman had the better of Moulton and the Conservative MP, although winning a television debate doesn't mean you're right.

I'd be eager to hear your views on the economist Steve Keen. He seems to be putting forward a radical agenda that would put the pain on the banks, which is where it really ought to be.

His views get an airing here:

http://news.bbc.co.uk/1/hi/programmes/hardtalk/9641873.stm

It seems crazy to spend billions saving banks that have shown an inability to invest wisely. Why not let them go to the wall and use QE to write off private debts and generate demand in the process?

Love the blog by the way!

[Andrew]

Terry, I'm afraid I didn't make it past the first paragraph of your response: it seems you don't know what the term "liquidity trap" means. At the risk of appearing rude, might I suggest that you look it up on the Google machine or something and then get back to me.

http://bit.ly/KvEBKo

Don't worry, I'll wait.

[Terry Smith]

Andrew: There seems to be a basic problem with our exchanges. I phrase a question in a manner you profess not to understand and so don’t have to provide an answer to how to fund further deficit spending. Or I fail to acknowledge what the term liquidity trap means, for which apologies-I was reading your post rather too quickly whilst working in New York-and so you can disregard the other 95% of my response including the multiple items of research which seem to support Afonso’s work. It seems like a pattern emerging.

[Terry Smith]

Chris: I found the clip of Steve Keen hard to play but I do not think what he is proposing would work. It was pioneered by amongst others Dr Gideon Gozo, Governor of the Reserve Bank of Zimbabwe with some rather spectacular ill effects.

[Peter]

I'm not an economist or financier but, as a keen follower of the debate around austerity, I continue to notice that the focus of debate is on the total amount of government spending / borrowing. Surely more attention is needed on what government is spending money on? Terry, for example, would you be in favour of government spending to support training / retraining people to become engineers or channel lending directly to SMEs that export? Whilst I understand that total spending has to be controlled and reduced, surely a better strategy is needed to drive up the amount of economic value added by government spending?

[Andrew]

Terry,
I agree that we don't appear to be making much headway here. Let me try a different tack.

The thread of your argument runs like this (it's a simplification but not an oversimplification, I hope!):

1. We don't have enough growth; 
2. Studies show that government spending is inversely correlated to growth.
3. Therefore, we should cut government spending.

I think we can both agree on 1(!). You think that I "don't like" the studies in 2 so let's get past that by stipulating that all of the studies you cited are correct, so we agree on 2.

That leaves 3. My problem with 3 is that, it doesn't automatically follow from 2. Why not? Because we've taken a general correlation and used it as evidence of specific causation which is not at all the same thing.

That's why I say the studies are irrelevant: because they are, by their very nature, generalizations that offer neither a model to help us understand the specifics of our current situation, nor policy prescriptions for solving it.

For contrast, here's the simplified thread of my argument:
1. The economy is depressed;
2. The attributes of this depression fit the model of a liquidity trap.
3. Therefore, we should pursue policies that resolve liquidity traps.

Here you initially disagreed with me on 2 but seemed to misunderstand what was involved in 3 so I'm not really sure what your position is on this now.

[G R Steele]

Paul Kugman is a charlatan. Details to support that claim are here:

http://www.iea.org.uk/blog/the-answer-is-inflation-what-was-the-question

and here:

http://onlinelibrary.wiley.com/doi/10.1111/j.1468-0270.2011.02131.x/pdf

[MickC]

Andrew,
I understood Terry to say that the problem is solvency-not liquidity.
Whilst not pretending to be an economist, it seems fairly obvious that the banks are quite simply insolvent. Thet are being loaned cheap money but are not lending it-even to businesses which are sound and could pay it back.
The solution to insolvent businesses, even banks, is that they are liquidated and the assets bought by other who can run the business.
The banks quite simply should not have been "rescued" but allowed to fail. The depositors should have been "rescued"-but in fact they are the ones who have suffered. I believe the normal term is that things are "arse about face".
Until this is addressed we will have stagnation.

[Terry Smith]

Andrew: I think that is progress. The studies may not fit the current circumstances because it is hard or even impossible to find examples of the current circumstances so it is hard to see what else to rely upon. My guess on perhaps the best comparator is the Long Depression of 1873-96. With regard to the policies which should overcome a liquidity trap, the ability to run an even more expansionary fiscal policy is handicapped by the running of deficits at the peak of an economic boom by the UK government and others which left us in the worst possible shape to implement such a policy. This was then compounded by the onset of the financial crisis in which governments expanded borrowings and liabilities in order to prevent, or maybe just delay, the demise of the banking sector. I would argue that it would be hard to fund a further expansionary fiscal policy in the face of this. And in any event, it has certainly not been contractionary yet in the United States and much of Europe including France and the UK, and even much in Italy notwithstanding posturing to the contrary. Where it has been contractionary, in the UK for example, it has primarily been through the route of higher taxes rather than any spending cuts. This allied to the studies I cite, which you don’t like but will accept for the moment to advance the debate, leads me to suggest that main stimulus should and will have to come through tax cuts, and that we will get better economic growth if we cut the government spend to allow larger cuts. Of course, there is also Quantitative Easing as a means of funding and to try to raise inflationary expectations but we have already done £325bn and the UK government owns one third of its own bonds. Clearly we could just print enough money to pay off all the debt and that problem would be resolved but it would of course leave us with another problem (see Reserve Bank of Zimbabwe for details) and the nearer we approach that extreme position the greater the risk.

[Terry Smith]

Peter: What you spend money on and how well it is spent is always of some importance. I would be wary of putting the government into the role of lenders to SMEs though. If you think the banks make a mess of lending, wait until you see what the government can do.

[JAD]

Terry
An opinion on Hector Sants interview in the Telegraph today please? I made a comment suggesting that whilst he was on the board of UBSP&D he was instrumental in forcing you out during the Accounting For Growth episode. Would this be correct and would you have appointed him to the FSA job?

[Terry Smith]

JAD: Apologies for the delay in responding. I didn’t have much of an opinion on the Telegraph interview as I don’t think it did more than repeat his previous comments. You are right that Hector was CEO at UBS P&D and was instrumental in firing me over the publication of Accounting for Growth. I certainly would not have appointed him to the FSA and not primarily because he fired me.

[Andrew]

Apologies for the delay in responding: I was busy cutting spending at home/stimulating another economy (aka: on holiday).

I'd like to ask you clarify some of your opening remarks above. Specifically, are you saying that *if* the government was running a budget surplus, we should increase government spending to escape the liquidity trap?

In other words, do you recognize that we *should* increase government spending but take the view that we *can't* or is your view that we *shouldn't* increase government spending under any circumstances.

Also, you don't need to go back to the 19th century for examples of liquidity traps: 1990s Japan is a very good example.

[Terry Smith]

Andrew: Welcome back. I’m not suggesting we have to look back to the Long Depression for an example of a liquidity trap but that it may be the closest parallel to our current circumstances. You are one for picking on a single remark and examining it rather than the whole of the argument, but the debate about whether we can or should increase government spending reminds me of the story about Napoleon marching through Russia. He and his Grand Army come to a village where all the defenders have fled and the occupants have taken shelter and he sends his men to find the mayor. When he has been found he is brought before Napoleon who says “I am the Emperor Napoleon and this is the Grand Army. It is traditional when we approach a village for the bells to be rung to greet us. Do you have anything to say to defend your behaviour before I deal with you?” The mayor replies: “There are many reasons why we might not choose to ring our bells to welcome an invading French army, but let’s start with the fact that we have no bells.” There is no additional source of money for government spending, so what I would do if there was is of no practical interest. Japan also seems to me to be an example of what happens if you don’t allow the creative destruction of the market cycle to occur. If you keep allocating capital and bank debt to companies which are bust or unable to produce an inadequate return on capital, and the banks keep pretending that the loans to those companies are sound and that they are solvent, then you have a recipe for a massive misallocation of capital which leads to the kind of zombie economy that Japan has experienced for the past couple of decades.

[Andrew]

My reason for picking one remark is because our whole debate is futile if, at the end of the day, you have an ideological aversion to increasing government spending under *any* circumstances.

But, since you prefer that I take on the whole argument, let me summarise your most recent comments and you can tell me where I go wrong:
1. The studies may not fit the circumstances but we should rely on them anyway.
2. We can't execute an expansionary fiscal policy because we have a deficit.
3. We should execute an expansionary fiscal policy ...but only using tax cuts.
4. We should offset 3. with a contractionary policy of spending cuts.
5. We can't use any more QE because we've done a chunk already.
6. We can't increase inflation targets because then we'll turn into Zimbabwe.

The rebuttals to which are:
1. Really?
2. I agree it doesn't help that we had a deficit going into this disaster but the idea that it prevents us from borrowing in order to fund expansion is just not supported by the data. In fact, it's a "feature" of the model (as proven by Japan's experience) that you can borrow vast sums of money without inflation or interest rates budging an inch. The reasons why that's true are explained in this post: http://on.ft.com/JuneE4
3. This is OK so long as we recognise that it's sub-optimal unless it's directly targeted at economic agents who are trying to repair their balance sheets (i.e. it's less useful to businesses and consumers who already have chunks of cash but nowhere to put it) and even then recovery will take longer because the multiplier on a tax cut is lower than that on direct spending.
4. This will cut the deficit but will also, by definition, contract the economy. 4 also has to be bigger than 3 (otherwise you're increasing the deficit) but somehow the effect of 3 has to be bigger and faster than 4...because 4 will also increase unemployment, unemployment benefits and, therefore, will negate a big chunk of your deficit reduction plan.
In short, you'll end up in the same situation as you are now with the bonus side effect that more people will be suffering.
5. I'm not advocating further QE because of its marginal utility when even long term interest rates are hitting the zero bound but you only need to look at the US which tripled its monetary base with no negative effects on inflation to see that, again, the normal rules don't apply here.
6. Ahh...the monetary equivalent of Godwin's Law ( http://nyti.ms/knoc0P ). Ordinarily this would mean that you automatically lose the argument but since we're having so much fun, I'm going to let it slide. ;)

As you can see, your Napoleonic analogy doesn't work since the lack of bells is an irrefutable fact whereas our inability to spend our way out of a recession is not.