Krugman on Cowen and Germany

Let's consider Krugman's three main points:

1. This was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand — it was trying to rebuild East German infrastructure to raise the region’s productivity.

2. The West German economy was not suffering from high unemployment — on the contrary, it was running hot, and the Bundesbank feared inflation.

3. The zero lower bound was not a concern. In fact, the Bundesbank was in the process of raising rates to head off inflation risks — the discount rate went from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this rate rise was a deliberate effort to choke off the additional demand created by spending on East Germany, to such an extent that the German mix of deficit spending and tight money is widely blamed for the European exchange rate crises of 1992-1993.

On #1, policymakers may intend all kinds of results, including a new skat table for Onkel Mathias and bananas for Brandenburg.  The scenario nonetheless saw a big boost in debt, spending, and aggregate demand, and in a setting with unemployed resources.  That makes it one test case, even if the primary motive was the unification of Germany and not stimulus per se. 

On #2, you willl find data on German unemployment rates here, for each half of the country and consolidated.  In the West there is unemployment before unification, a big boost in employment during the first two years of unification, and then much higher unemployment.

Let's track those rates, starting in 1989: 7.9, 7.2, 6.2, 6.4, 8.0, 9.0, 9.1 (1995), 9.9, 10.8, 10.3, etc.

You can read those numbers two ways.  First, stimulus worked until they lost heart, or "it boosts the economy in the short run but it postpones adjustment problems and in the medium run you end up with a poor and sluggish private sector job market."  I was making the simpler historical-explanatory point that, no matter how you slice and dice the data, the poor outcome in absolute terms explains why the Germans are not so impressed by ideas of debt, spending and aggregate demand.  And if stimulus proponents keep on losing heart at the critical moments, the citizenry is still right to be skeptical.

The real story requires a look at the tottering East German labor market as well.  At the immediate moment of unification, unemployment/underemployment for the consolidated Germany are higher than the above numbers behind the link indicate; read for instance these comments and also here

The strongest criticism of the example is not one that Krugman considers.  If you had access to a more finely calibrated employment index, reflecting the gross underemployment of DDR workers, with continually collapsing jobs, there is at least some chance the true data series might show more effectiveness for fiscal policy than the published data, or the West German mood at the time, would indicate.  

#3, like #1, is a distraction.  The zero bound might — in some frameworks — make fiscal policy necessary rather than monetary policy.  But the zero bound is not required to drive the main arguments that fiscal policy is effective with unemployed resources.  So historical examples with a non-zero bound and ineffective fiscal policy do count against fiscal policy. 

As an aside, you can find some RBC and cash constraint models where fiscal policy is more effective at the zero bound, but a) I think these papers are deeply flawed, b) the liquidity constraints in those models do much of the work and those constraints held anyway for parts of East Germany, and c) Krugman and others are advocating fiscal policy for a wide variety of economies, not all of which are at the zero bound, even if they have constrained monetary policy for other reasons, such as Ireland.

On #3, Krugman is correct that the Bundesbank actions hurt the German economy (though keep in mind, at the time of tightening in 1992 the rate of German price inflation was five percent and it stayed at 4.4 percent the year after).  This implies that tight monetary and loose fiscal policy, taken together, won't work.  I endorse that conclusion.  It also shows that the monetary authority moves last, which is exactly the point made by fiscal policy critics such as Scott Sumner.  Stressing that point does no favors to the argument for fiscal expansion, quite the contrary.  Krugman is eager to slap down the historical example but he is losing track of the broader principle he cites to do so.

Overall the pro-ramp-up-the-spending fiscal policy advocates are keener to produce examples which don't count than examples which do count.  The positive arsenal is pretty weak, consisting mainly of World War II, an experience which cannot be repeated or replicated.

Krugman also directs his attention at a secondary point in the argument, taking up a single paragraph in the column.  He doesn't touch the main point: Germany cut off fiscal stimulus early and focused on the real economy and they're doing fine.  Even if you think this prosperity is at the expense of others (and I don't), the pro-ramp-up-the-spending-stimulus view suggests that Germany itself should be ailing, yet it isn't.  Here are further good comments on that topic

On the main point of the column, you can find some good criticisms from Ryan Avent, though I would stress it is exports not stimulus that led the German recovery and that Germany is not obviously due for a spill.


I think Krugman makes several good points, but that will not stop the ad hominem attacks that I'm sure will follow.

On PBS’s NewsHour with Jim Lehrer, senior correspondent Gwen Ifill used “teabaggers† as well. At the New York Times, Paul Krugman used it in a column.

Stay classy, Paul.

Why can't Krugman be just a bit more civilized?

Andrew makes a very good point. Any time I see a meaningless invective like "teabaggers" used, that person loses all credibility with me. It's that utter contempt for those that disagree with them that turns me off to many writers, Krugman especially.

The problem I have with both sides of the argument is that we (I guess I am part of the problem) are always using an "n" of 1. The Great Depression was an event in itself. Japan in the 1990s is different from Germany in the 1990s -- I think it would be difficult to throw them into the same regression equation and simply try to control for their differences. The US now is different from Ireland -- what might work there might now work here.

I think we are all muddling through, with some general idea about what appropriate responses should be -- and from my perspective that includes more stimulus (there I go). There is little evidence that the bond market is scared of us.

I think what makes the US stand out from the rest of the world is an incredibly innovative population, but one whose innovation is threatened not by federal economic policy, but by the foreign policy hubris of the 2000s. No, our foreign policy hubris did not directly cause the financial crisis but that hubris played an important role. Two reasons I can think of now:

1) Irresponsible behavior has a way of rubbing off, especially since the folks on Wall Street are so cozy with the folks in Washington. Could you imagine the cocktail parties? The arm chair generals saying we are going to kick ass and show the world America really means business. It is not surprising that Wall Street titans soon thought the same thing.

2) America's magic is an incredible self belief. We are losing that. Other events like BP are simply rubbing salt in the wounds. When I hear stories (not anecdotal but frequently) that potential immigrants could make it as big elsewhere, I know we are in trouble. When it takes Chinese 3-4 months to get visas to come here, I know we are in big trouble. (You can get a visa to go to China in less than a week.)

I feel like I am moralizing here, but point is that we need a self-belief boost. Declare victory and bring the troops home from Iraq; hold victory huge parades in every major city. Get the propaganda department to work. Shoot an asteroid out of the sky or something ...

We will have another n of 1 to generalize about.

The advocates of stronger fiscal stimulus, and Krugman is the point man on this, have an absolute need to downplay any evidence to the contrary, and that's what he's doing here. He may not be doing it intentionally, but he is clearly biased and going out of his way to discount real world evidence. It's a "No True Scotsman" fallacy.

But as Tyler said, the evidence for the long-term efficacy of fiscal stimulus is hard to find. I'd go further - if fiscal stimulus works as advertised, we should find evidence that countries which engaged in fiscal conservatism have not performed as well as governments that have consistently propped up economies with deficit spending.

I'd look at the experience of Canada and the few other countries that have managed to move from large deficit spending to either lower deficits or even supluses. Canada had a large deficit in the 1980's, and we moved to a period of yearly government surpluses, and we did not have a corresponding fall in GDP.

Canada reduced the size of its government as a percentage of GDP from a peak of 53% in 1992 to about 39% today. During that period, we lowered our public debt from about 70% of GDP down to 32%.

During that same period, our trend in GDP growth, accounting for recessions and world conditions, doesn't appear to have decreased at all. In fact, as the debt has been paid down, Canada's economy has become stronger, and we may have the strongest economy in the world right now. We're creating more absolute jobs than is the U.S., with 1/10 the population. Our unemployment rate is 2 points lower than the rate in the U.S., and it's going down faster. And even now, our deficit is lower than GDP growth, at about 2.5% of GDP, and we expect to be running surpluses again within a few years.

I believe similar patterns can be found in other countries that have reduced the size of their deficits and debt. Starting in 1984, New Zealand tightened its fiscal policy and began eliminating debt-financed subsidy of agriculture and industry, causing the economy there to improve quite dramatically.

Then there's the counterexample of Japan, which has been trying to stimulate its economy with borrowed money for a long time, and now has a debt of 160% of GDP with nothing to show for it other than a lot of overbuilt, under-utilized infrastructure and non-competitive companies. Of course, Krugman has an explanation for that too - they didn't do it right. They stretched it out too long, they didn't loosen their monetary policy enough, etc. My answer to that would be that if your fiscal stimulus is so sensitive to being done exactly right, then it's foolish to expect it to work when handed over to a gaggle of politicians for implementation. Any plan that doesn't take into account the efficiency of government, the political patience for debt, and the deviations from pure theory that will occur when politicians horse-trade votes... is a plan not ready for the real world.

It seems to me that we're entering a period where we should be able to settle this question, as there is a clear break between policies in different countries right now. Europe and Canada are moving forward with fiscal restraint. Other countries are not. I'd challenge Dr. Krugman to put his belief in fiscal stimulus on the line and make some predictions as to what the result of this should be. I assume that he believes that average increase in GDP growth in the countries which continue a program of fiscal stimulus will be higher than the average increase in economic growth in countries which don't. It would be nice to get him on the record before the results come in, so he can't dismiss them after the fact as not being relevant.

A Keynesian Success Story: Germany's New Economic Miracle,1518,707231,00.html

This may be off-topic but shouldn't we be talking about the tax increases next year. Romer and Romer's June 2010 article on exogenous tax increases

Next year's tax increases (ie sunset of the Bush tax cuts) aren't exogenous. They were written into the original bill and therefore everyone in the market has known all along that expiration was coming and adjusted their expectations accordingly -- according to standard models, anyway.

I think I mentioned this before: It is impossible to have a discussion with PK on a pure economics level. He is a political hack, and as such everything he says is aimed at political goals and not economics.

This is clear on the whole argument about the differences between government spending and tax cuts. No matter what the data are, the point is that he think tax cuts will benefit the rich and government spending will benefit the poor. If we have to pay for that with lost GDP, so be it.

So really Tyler, you should just forget about him. I know you are honestly interested in debating Krugman the economist but I am afraid that is impossible - Krugman the hack will kick you out every single time.

It's fine to have a debate. If only.

The only argument I heard from Team Krugman on debt was "you dumb hicks don't understand that we are a fiat country and not a family budget."

Well, do you guys think John Hussman is a dumb hick that doesn't understand financial accounting?

He appears to me to be saying that de-leveraging must run its course before the economy will be in a position to begin re-expansion led by credit-driven purchases.

If Krugman just wants people employed, then that's fine. If he wants to stimulate the economy, that may not be possible.

"In other words grown-ups often have to put up with childish things ... "

Like reading Krugmans ranting. Not worth the time, most days.

Do you mean that all people at economics seminars are conceited and more interested in politics than economics? I find that hard to believe.

Also, the fact that the defict decreased during the Clinton years has much more to do with the macro situation of the time than with actual cuts in spending. Regarding Bush, he was not a fiscal conservative by any means but besides the 2 wars and the new medicine benefit his spending profile was pretty close to Clinton's. To say that Krugman and others were deficit hawks is really absurd.

The Clinton Surplus was the result of:

- Military Downsizing (The "Peace Dividend").
- Divided Government and gridlock.
- The dot-com boom.

Basically, revenues rose fast, and the government was too divided to be able to spend the money or lower taxes quickly enough to overcome that trajectory.

Eventually, Bush was elected, and the Republicans ended deadlock. And then they immediately started raising spending and cutting taxes. Then 9/11 shocked the economy, government bloated up even more with increased military spending and homeland security spending, Bush signed off on a new entitlement and threw money willy-nilly at education and other big-cost programs. Along with this the social security surplus that was used to hide the structural deficit declined.

So you can put some blame on Republicans, but you can't really give the Democrats any credit.

@fyi: I wrote "tone" and that's what I meant. Economists are extremely rough in how they criticize each other. So much so, that interaction with other academics is often difficult.

Whether or not Krugman is a "hack" (though I disagree with that, too) is an entirely different question from him being "uncivilized" or making "ad hominem" attacks etc.

And clearly Clinton's White House wasn't the sole cause of the balancing of the budget and conditions were quite favorable.
And of course there would have been ways to spend the money. I find divided government a pretty weak explanation, considering that government was divided before 1992. And it seems quite unlikely to me that Clinton wouldn't have been able to get a mix of Democratic pet programs, pork barrel and some Republican pet programs like top bracket tax cuts through Congress.
And if you think that "To say that Krugman and others were deficit hawks is really absurd." I invite you to look up Robert Reich and dig up some of the old policy discussions from the 90s. The left wing of the Democrats was lobbying with all its might to spend the increasing revenues and the Rubin/Summers/de Long axis (with which Krugman was 100% ideologically aligned - he hated Reich's guts) was an important factor in keeping the White House on a deficit reduction course.

Tyler, I know nothing about the German economy in the past 30 years, and in particular the last 20 years. I'd appreciate it greatly if you can provide a list of studies based on detailed academic research of its performance. Also, if there is any good survey of these studies, especially as part of a comparative analysis with the experiences of other countries, please provide me with the reference. I look forward to your reply.

The scenario nonetheless saw a big boost in debt, spending, and aggregate demand, and in a setting with unemployed resources. That makes it one test case, even if the primary motive was the unification of Germany and not stimulus per se.

That's a bit of a heroic assumption IMO. Yes East Germany had resourses that were unemployed but were they ready to start going to work to meet an upsurge in demand? After decades of communist mismanagement I think not. While many of the workers might have had good human capital, they were probably lacking a lot of important mental capital of working efficiently in a market system. I'm sure the story with the East's physical capital was even worse. The gov't was hoping to upgrade the lack of capital quickly before the increase in demand would cause a run up in prices.

In more technical terms, West Germany had a lower natural rate of unemployment than East Germany due to the massive supply side problems left from communist rule. In such a case, Germany as a whole was closer to full employment than would appear by just looking at the percentages. Granted the increase in spending is stimulus even if the gov't intended it to boose the supply side. However stimulus in a full employment economy does not tend to produce much increase in real GDP.

Krugman was wrong to be so blunt in venting his frustration. Point taken. Here are some general problems with those currently arguing against stimulus.
1. Many critics of the *idea* of Keynesian policies are ignoring the evidence put forth by proponents of it;
2. Some, with Mr. Cowen among them, are offering data against the stimulus that is not fully correct, or is not very relevant to the Keynesian case;

The basic problem, which few have seemed to notice, is that Mr. Cowen is making a simple fallacy of composition here; that deficit spending initiative was bad, therefore all deficit spending initiatives are bad. Another problem is that Mr. Cowen's interpretation of the unemployment data is a bit too "convenient." Many of the libertarian crowd have staked the claim that European unemployment is persistently higher because of generous welfare states. To turn around and also claim that unemployment rates slightly higher than those in the US at one particular point in time are to be blamed on a particular isolated deficit episode seems, well, "convenient."

Krugman eventually concede that the German unification deficits were not sound economic policy. But, he is understandably frustrated that the Anti-Keynesians (Mr. Cowen included) seem to be ignoring the actual points Keynesian have been making. Instead, they seem to be arguing a more general point about deficits, which has Mr. Krugman nostalgic for Hooverism. Krugman is merely pointing out that not all deficits are the same. He's right.

To close, what Mr. Cowen has done reminds me of an old joke: A man comes across an economist standing under a lamppost staring at the ground, so he asks him, "Did you lose something?" "Yes," replied the economist, "I dropped my keys." "Did you drop them over here somewhere?" "No," answered the economist, "but the light is better over here." In other words, in looking for evidence against deficits during a recession, he has looked for evidence of deficits being harmful during non-recessionary times. And there, he sort of misses the point.

Dave, That reference to Japan is fairly easy for Krugman, Bernanke or anyone else to answer: they didn't stimulate in the beginning and went through several years of relying on monetary policy and extremely low interest rates, and even had a deflationary period. Only later did they resort to fiscal stimulus, which did have an effect, but then they withdrew it quickly, as the world economy accelerated. You might want to look up some of the Bernanke statements on this.

If we just rely on monetary policy at the zero bound, yes, Japan is relevant, but not for the reasons you think. The lesson from Japan is: stimulate quickly and do not rely solely on monetary policy.

"Next year's tax increases (ie sunset of the Bush tax cuts) aren't exogenous. They were written into the original bill and therefore everyone in the market has known all along that expiration was coming and adjusted their expectations accordingly -- according to standard models, anyway"

Chris, that's actually not the point of the paper. Exogenous is not equivalent to unanticipated in their construction. It just means that the tax increase was not due to the prevailing economic conditions. Since this tax increase was pre-programmed, it would appear that their conclusions ("an exogenous tax increase of one percent of GDP lowers real GDP by almost three percent") are not easy to dismiss. There was also a section on expectations. The conclusion was "there is only slight evidence of expectational effects."

I'm much more afraid of the impending tax increase than I am of any lack of a stimulus bill that Congress can slap together.

Bill, Krugman may be a good economist, but he isn't writing economics anymore. He's writing politics, which is backed up by a version of economics that somehow always manages to align itself with Krugman's politics. Odd, that.

afu: Krugman is already defending himself by saying that the stimulus won't work because it wasn't big enough. Of course, if the stimulus works, then he'll claim that it was all his idea, and that it was just the right size.

"I think what makes the US stand out from the rest of the world is an incredibly innovative population..."

I think what makes the US stand out from the rest of the world is its ability to increase its population. 3% growth per annum in population can do wonders for government debt per capita. Growth in the US can be achieved just be letting the population grow, so long as per capita output stays the same; it's not the same for Germany, where population growth is zero or even negative.

"Next year's tax increases (ie sunset of the Bush tax cuts) aren't exogenous. They were written into the original bill and therefore everyone in the market has known all along that expiration was coming and adjusted their expectations accordingly -- according to standard models, anyway."

GS, in its latest forecast, is still thinking that at least some of these tax cuts might or will be continued. So it's probably difficult to claim that people are anticipating the end of the tax cuts. Maybe, but maybe not.

"So you can put some blame on Republicans, but you can't really give the Democrats any credit."

IMHO you can put 100% blame on Republicans; but still you can't give the Democrats any credit.

This I really love:

Only later did they resort to fiscal stimulus, which did have an effect, but then they withdrew it quickly,

Really, then where did that public debt, now pushing toward 200% of Japan's GDP, come from if the stimulus was withdrawn so quickly as the pro-Keysian's claim? Should Japan have a debt of 400% of GDP today? How about 1000%? Please explain what is too much and what is too little in regards to Japan.

Yancey and Ryan,

Look (and think?) just a little beyond Libertarian orthodoxy:

Stimulus, while increasing debt, also increases growth, so the ratio doesn't increase nearly as much as you might think. Debt increases follow more from a decline in growth than from an increase in deficit spending. Two clear examples of this besides Japan include:

(1) The onset of the Great Depression, where the debt ratio increased more under Hoover than it did under Roosevelt. (Yes, Roosevelt was the big spender).

(2) Our current debt ratio, which increased far more from the recession following Lehman Bros. than it did from the stimulus bill.

The stimulus bill has had no appreciable influence on our long-run budget problems. Indeed, looking long-run, the health care bill has likely done far more to improve the budget situation than the stimulus bill has hurt.

I would personally prefer to see more aggressive monetary policy over more fiscal stimulus. But the Fed seems reticent to try such aggressive and untried measures. It is clear that more fiscal stimulus would help and cost very little long run. It may even reduce the debt to GDP ratio. If the Fed's not going to act, I'd much prefer more fiscal stimulus over high unemployment and possible deflation. Deflation is very, very bad.

Boonton: EXACTLY!

This is textbook. The evidence and theory have been around for a very long time. We see it in front of our eyes again today. History repeats itself. Again, and again. Yet we still hear tired, tireless and totally false arguments from people who should know better, probably do know better, but struggle to misinform the masses.


You have to link to a Chicago lawyer to bolster your case? Are you that desperate?

What happened with the reunification of Germany is entirely different from the present situation resulting from the financial crisis. The 1 to 1 conversion was not only highly inflationary, but made east Germans with cash suddenly feel rich. And they went on a almost unparalleled spending spree - in the west. The high exchange rate, however, priced east German products out of the market and destroyed the economy in the east, which literally imploded. The east Germans wouldn't even buy their own produce - it had to be in pretty packaging from the west.

The official unemployment rate was kept low by large "make work" programs. Young, ambitious east Germans (mostly women) moved west in droves to find jobs (and husbands) leaving a residue of employable people priced out of the market by the high exchange rate and government/union wage policies which kept their wages above the more productive workers in the west.

The west had to pump trillions (and counting) into the east to a great extent just to keep body and soul together. The chronically unemployed have become basically unemployable and will remain a drain on the west until they die.

How can you compare that with our situation today? You have to have a funny pair of glasses to see parallels here.

Then, giving cash to 18m desperately poor east Germans who then spent with a vengeance, pushing up inflation, which required the Bundesbank to stomp on the breaks, which resulted in the worst recession post WWII Germany had experienced up to then.

Now, central banks flooding the system with cash, but nobody willing to spend; deflation a real threat.

Then demand was greater than supply; now (potential) supply is greater than demand.

Solution then - rise interest rates to cool demand. Solution now - let the government pick up the slack.

Boonton has it exactly right about the market signals and debt. However, comparing individual debt ratios to national debt ratios is a significant error. Individuals making their own decisions on debt is much more likely to produce sustainable growth than a small number of government officials borrowing $5k for every man woman and child in the country to finance political boondoggles.

The uses of the debt should count more than the amount. If you trust politicians to use it better than individuals; you haven't been paying attention.

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