William Galston

Responding to Paul Krugman

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It may surprise some people to learn that I intend my TNR columns to start conversations, not end them. I offer what I hope are evidence-based arguments, with full awareness that others may know more than I do. In the end, I am satisfied if the debate has advanced.

My most recent column is a case in point. In it I raised some questions about Keynesian economics, and also about Paul Krugman’s use of Japan as a leading indicator of the risks to which the U.S. economy is exposed. Krugman’s terse response makes two main substantive points. (I set aside the suggestion that before I had the right to respond to his column in The New York Times, I had the responsibility to be thoroughly familiar with his entire oeuvre)

Krugman’s first point is that I shouldn’t have employed Reinhart and Rogoff’s claim that a debt/GDP ratio above 90 percent slows economic growth because he has already “refuted” it. I invite readers to consult the two blog posts he cites and decide for themselves whether he has in fact refuted the proposition or has simply raised questions about it. Because I am parti pris, you can apply whatever discount you want to my view that it is closer to the latter than to the former. 

At any rate (and I hope we can agree on this), it’s a matter of some importance and urgency to get to the bottom of the disagreement between Reinhart/Rogoff and Krugman. If Reinhart/Rogoff are right, then they’ve provided a strong case for slowing and then halting the current rapid increase in our public debt. If they’re wrong, there may still be good reasons to do so, but slower economic growth isn’t one of them.

We need to know the answer, well before President Obama’s fiscal commission pens its report. Can economists organize a discussion of this question? And if they already have, can they make it available to the rest of us?

Krugman’s second point is thatbefore I say anything about Japan, I should read Adam Posen. Because I’m always happy to accept homework assignments, I have read the paper to which Krugman called my attention. As even this non-economist could tell, it’s a splendid piece of work (the link is to a PDF). In light of Krugman’s claim that the best policy for the United States is continued fiscal stimulus plus a monetary policy designed to ward off the threat of deflation, the following matters caught my attention.

(a)    Posen regards Japan’s economy between 2002 and 2008 as a success story attributable to a combination of fiscal stimulus and structural reform. I guess success is in the eye of the beholder. During those seven years, growth averaged 1.4 percent. Even if you lop off 2002 and 2008, growth during the five golden years in between averaged 2.1 percent while the budget deficit averaged 5 percent of GDP. And this in a country whose growth averaged 4 percent in the 1980s and more in the previous decades. I doubt that the American public would be satisfied with Japan’s 2003-2007 performanceand they’d be right not to be.

(b)   However we may judge the results of Japan’s economic policies, Posen offers several reasons to believe that those wouldn’t be directly applicable to the United Kingdom and, by implication, the U.S. Here’s the key one: because Japan enjoys a “relative closedness and passivity of its domestic savers and investors,” fiscal stimulus tends not to leak out overseas. Because British capital is more mobile, “fiscal stimulus will be more limited in its effect and less sustainable on a large scale in the UK than it was in Japan.” In this respect, the United States is far closer to the UK than to Japan, suggesting thatall other things being equal, the effects of fiscal stimulus is likely to be more muted here as well.

(c)    Posen regards it as a puzzle, calling for more research, why Japan’s monetary policy, which included its version of “Quantitative Easing,” had relatively little effect on the deflation it was designed to combat. And he draws an important conclusion, which I will quote at some length:

“The ... lesson for me, as a central banker, is to have much more humility about what we are capable of doing with monetary policy, especially with unconventional measures. Monetary policy has been unable in Japan to remove deflation quickly in any easy way. ... We also do not understand deflation very wellwhatever type of standard macro model one uses for analysis, you will find it difficult to generate the persistent for a decade, sticky, but steady at -1%, deflation that Japan experienced, rather than something that accelerated either up or down, and did more harm. As a result, we should stay away from very mechanistic monetarism that ‘Oh, boy, they’ve printed a lot of money so at some point it has to turn into inflation.’ Or, ‘If we do this specific amount of quantitative easing, so it will lead to this result.’ Looking at Japan, it is clear that their quantitative easing measures had the right sign, in the sense of removing fears of tightening, but did not have a predictable or even large short-term result, let alone cause high inflation.”

For my part, I’d suggest that the key word in the paragraph just quoted is “humility,” a regrettably scarce commodity. Perhaps that’s one reason why it’s so valuable.

ERRATA: Now is a good time for me to correct two small but distressing mistakes I made in my column. First, Barry Bosworth was the head of the Council on Wage and Price Stability, not the CEA. And second, my former University of Maryland colleague Carmen Reinhart spells her name without the “d” I inserted for no good reason.

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