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Friday, December 2, 2016

Defending Krugman: The Importance Of Keynesian Economics

Keynes was right: increased government spending in the U.S. is necessary to decrease unemployment and raise demand in the near-term.

Paul Krugman hardly needs defending, but his views about the need for Keynesian stimulus in the U.S. right now are coming under considerable fire from centrist and left-of-center economists. I find this disturbing because Krugman’s view abides by basic Keynesian principles that seem to have been discarded by many who profess themselves Keynesians. Is there a wide misunderstanding of Keynes?

What seems to upset people is that Krugman argues the government must spend more money now, almost regardless of what it spends it on. The Keynesian thesis is that economies can settle at a high level of unemployment rather than re-adjust to the optimum unemployment level—or level of economic activity—on their own. This was a response to the classical, pre-Depression view that the beauty of free markets was a self-adjustment process based on falling prices in downturns. But ultimately the problem is a lack of demand, and Keynes advocated budget deficits to support an increase in demand.

The lack of demand in the economy now is palpable. Krugman’s contention is that in the near-term, we can solve this problem if we have the will to do so. The economy can reduce its rate of unemployment fairly rapidly with adequate Keynesian stimulus. It is clear that monetary stimulus at this point is not enough.

This view is not incompatible with longer-term concerns about the economy — inadequate education for too many, infrastructure decay, old energy technologies, and so on. Many seem to criticize Krugman for not acknowledging “structural” changes in the economy, and they implicitly agree with classical conservative observers that the unemployment rate really can’t fall much below 7 percent. I can’t speak for Krugman, but he seems to be saying that we should not mix up longer-term structural issues with near-term demand inadequacy. It’s very likely the unemployment rate can fall much farther without igniting inflation.

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