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June 28, 2010

Krugman is calling this the Early Stages of an Economic Depression and Greg Mankiew Talks about the Risks of Stimulus and Overspending

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Paul Krugman is predicting/observing/declaring that United States (and the world economy) is in the early stages of an economic depression. Krugman is saying this would be more like the Long Depression of 1879 than the Great Depression of the 1930s. A more modern example is it will be like the long Japanese stagnation but worse. Krugman seems to be saying this will and is happening because there is trillions of more dollars that are needed for more economic stimulus and all of the states and local government must be bailed out.

And this third depression will be primarily a failure of policy. Around the world — most recently at last weekend’s deeply discouraging G-20 meeting — governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending
.

Krugman previously showed the math that he is using to ballpark stimulus size.
* Okun’s Law, the relationship between changes in real GDP and changes in the unemployment rate
* Estimates of the Okun’s Law coefficient range from 2 to 3
* How much do tax cuts and spending raise GDP? The widely cited estimates of Mark Zandi of Economy.com indicate a multiplier of around 1.5 for spending, with widely varying estimates for tax cuts. Payroll tax cuts, which make up about half the Obama proposal, are pretty good, with a multiplier of 1.29; business tax cuts, which make up the rest, are much less effective.
* About $300-600 billion to reduce unemployment by 1% for the USA for about one year
If I understand it correctly, then a four year stimulus to reduce unemployment by 5% for all of those years would be $1.2 to 2.4 trillion.

Greg Mankiew talks about the risks of government stimulus.

Increased government borrowing may also drive up long-term interest rates, which could make it difficult for people to borrow money and could therefore reduce spending today.
* People can anticipate higher future taxes and therefore cut back on their current consumption.



Unemployment — especially long-term unemployment — remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.

In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.

The Obama administration understands the dangers of premature fiscal austerity — but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts at the state and local levels.


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