May 5, 2012

Weekend Reads: The Incredulity Problem

Paul Krugman:

“But in the economy as a whole, your spending is my income and vice versa; my wage matters only in comparison to your wage; and so on. This changes everything, which is why we have paradoxes of thrift and flexibility.

Of course, that’s why we do economic modeling: precisely to scope out the areas where personal incredulity is a very bad guide to affairs.”

A five-minute piece on Krugman's weblog puts the lie to the 'I can't believe further spending could be good for the economy' meme.

Macroeconomics isn't a blindingly obvious pursuit. That's why economists spend careers studying and expounding on it, why economic models come and go as ideas prove false over the long haul.

Where we are today, though, is textbook liquidity trap territory, as expounded on by professor Krugman the past few years. In this situation, government austerity is exactly the opposite of what action should be taken, as can be seen by its effect on the recent UK economy.

US government spending is headed for automatic, deep cuts at the turn of next year. In effect we'll be going on our own austerity program. It would appear, from the evidence all around us, that austerity is not the right direction we should take. What to do?

As the man says, when you find yourself in a hole, stop digging.