Krugman and 'The Lesson'

Updated below

Paul Krugman published this column in the New York Times yesterday, in which he chastises the Right for being so hard on The Ben Bernank. While the right has become critical of the Fed (thanks to Ron Paul), Krugman says that our problems stem from too little action from the central bank. Instead of fretting over the prospect of inflation, we should be concerned that not enough inflation is taking place.

Krugman is dreadfully wrong on his prescription here. He argues that because a lot of businesses are loaded down with large amounts of debt, “modest inflation” would relieve that by “eroding the real value of that debt.”

First, this assumes that all or most of these businesses will receive newly-printed money before prices rise, thus allowing them to pay down their debt with a devalued currency. If not, the alternative would be that, on top of the still-burdensome debt, prices for producers’ goods would rise, thus compounding the problem further. The fact is, new money is never spread evenly, as Henry Hazlitt describes in Chapter 22 of Economics in One Lesson. He uses an example of military expenditures paid for with inflated currency.

Let us call the war contractors and their employees group A, and those from whom they directly buy their added goods and services group B. Group B, as a result of higher sales and prices, will now in turn buy more goods and services from a still further group, C. Group C in turn will be able to raise its prices and will have more income to spend on group D, and so on, until the rise in prices and money incomes has covered virtually the whole nation.

This of course takes time, thereby adversely impacting each successive group, as prices rise before they receive higher wages.

The only way to avoid such an outcome would be to give new money directly to these indebted firms. This is in effect, a bailout. The moral hazard of such a policy would be devastating, and would only incentivize businesses to pile on debt, implicitly knowing they would be covered should they be unable to pay it off.

Second, this rosy scenario presupposes that on net, the economy will be better off with higher prices overall, even if firms have little to no debt. However, if debt were no problem for some businesses, but the money bought less for everyone, I doubt such an economy would be all that robust.

Third, the other part ignored in this is the impact on the credit markets. Inflation tends to benefit borrowers to the harm of lenders, because the notes are repaid with a debauched currency. If we weren’t living in a time of excessive credit spurred on by the Fed it would be wholly immoral to debase the currency in order to benefit some heavily indebted corporations. Given that we don’t have a free market currency or interest rate this I suppose is less dubious, but it’s no less devastating to the poor and anyone on a fixed income.

It doesn’t end there, however. Krugman continues:

Meanwhile, other parts of the private sector (like much of corporate America) are sitting on large hoards of cash; the prospect of moderate inflation would make letting the cash just sit there less attractive, acting as a spur to investment — again, helping to promote overall recovery.

What isn’t considered in this statement is why firms are hoarding cash. If these corporations are already leery of inflation, and are sitting on cash in the event that prices rise, inflation isn’t likely to drive them to spend this money. Instead, such firms, and likely others with them, will only hold cash in greater quantities.

But even if they would be motivated to invest their reserves, this still assumes, as with the above critique, that inflating the currency will be a net benefit to the whole of the economy. In the event these cash-heavy firms started spending their billions, prices would be driven up even further. It isn’t clear prima facie that having newly employed workers will necessarily be a benefit if everyone is stuck paying higher prices.

In his analysis, Krugman shows himself to be the bad economist Hazlitt describes in the opening chapter of his primer:

The bad economist sees only what immediately strikes the eye; the good economist also looks beyond. The bad economist sees only the direct consequences of a proposed course; the good economist looks also at the longer and indirect consequences. The bad economist sees only what the effect of a given policy has been or will be on one particular group; the good economist inquires also what the effect of the policy will be on all groups.

Update:

One of the more inane comments I’ve read online in recent times was posted in Krugman’s column. Doug wrote; “Dr. Krugman it would also be instructive to mention why the right pursues anti-inflationary policies, and why so much of our fiscal policy is directed toward that end – rich people hate inflation.”

For all the supposed “anti-inflationary policies” this guy thinks are being floated out there by the Right, there haven’t been any in the US for decades. Couple that with the fact our two most prolific inflators in American history were nominated by GOP presidents. Alan Greenspan, who orchestrated both credit-induced bubbles of the Tech and housing markets, was nominated by Ronald Reagan, George H.W. Bush, and George W. Bush. The Ben Bernank, who has overseen TARP, QE II, and Operation Twist, was nominated by George W. Bush.

The second part of this absurd claim is that “rich people hate inflation.” As if the poor would love rising prices!

In the first half of last year, Americans spent almost 8 percent of their monthly income on gasoline. Contrast this with a “rich” person; let’s say someone who earns a million bucks a year, who would pay only a fraction of one percent of their income at the pump. Gas prices would only have to rise modestly for it to drastically affect the poor or middle class. However, fuel could increase five or ten fold before our “rich” person would likely even notice. Does Doug really think people like Mitt Romney and George Soros care whether gas is $3 or $30 a gallon?