Paul Krugman makes the Alliance seem Right-Wing

Keith Rankin, 10 August 1998


Paul Krugman's solutions for the Japanese economic depression, as spelt out at tonight's lecture at Auckland University, fall well to the left of anything that the Alliance would dare to propose. Yet his solutions do not fall outside orthodox economics. His proposals are 'textbook economics which you would not find in any textbook'. While orthodox, Krugman is not politically correct. Academic economists in New Zealand without tenure would be risking their careers if they said the sorts of things that Krugman is saying.

In short, Krugman says that Japan needs inflation; Japan needs to print sufficient money to ensure many years of rising prices (ie rising by more than 3%). Given that nominal interest rates cannot fall below zero, inflation is the only way to generate the negative real interest rates that are needed to reverse the "liquidity trap" that Japan finds itself in.

Japan's problem, excessive savings, is so ingrained that even interest rates of 0.38% are insufficient to get firms to make use of all Japanese' unspent incomes. The only way to make them reduce their savings rate is to make their money depreciate (ie to eventually become worthless) if it is not spent.

There remain two problems with a policy of printing money, one that Krugman noted, and one that I would add and that does go beyond the orthodoxy that Krugman confines himself to.

Krugman noted that the Japanese Central Bank would have a "credibility problem" if it adopted an overtly inflationary policy (and it would have to be overt to have the desired effect). The problem is that people would expect that, once the emergency was over, the central bank would revert to type. Central banks worldwide have a culture that demands being tough on inflation. If people expected that an emergency reflation would be discontinued once the emergency was over, then they would not spend their savings, and therefore the problem would not be over.

In New Zealand, low interest rates are not boosting investment as low interest rates have done in the past. New Zealand firms have been burnt in the past by being seduced into expansion, and then being clobbered for having created inflationary expectation on account of having expanded. The Japanese central bank would have equal difficulty getting people to believe that it was running a long term policy of inflation.

The savings problem is not simply one of Japanese culture. It is a problem exacerbated by the perceived need for "retirement savings". As in New Zealand, the Japanese people think that savings will secure their future. But, as Krugman noted, while savings makes sense to individuals, collectively the act of saving for retirement just exacerbates the problem of supporting ourselves in retirement. For society as a whole, excess savings means negative economic growth, which means less for everyone when they retire. And the higher the collective rate of excess savings today then the bigger the collective hole they are digging for themselves tomorrow.

Krugman noted that tax cuts could do little in Japan to stimulate spending, and even an increase in Government spending might not do enough. That is, Japan needs a simultaneous fiscal and monetary reflation. Keynesian reflation is wrong only inasmuch as it is inadequate. Not even the Alliance could dare advocate such a policy, even if New Zealand was in Japan's current circumstances.

The problem that I can see with the Krugman solution is that monetary inflation (ie printing heaps of money) in Japan may not actually lead to higher prices. We know in New Zealand that monetary inflation simultaneous with high interest rates led to a doubling of inflation rates in 1994-96. But a flush of cheap money may simply generate further production, more economies of scale, and more discounting. The people will not be persuaded to part with their money until prices actually start to rise. My critique is unorthodox, because it questions the automatic link from monetary inflation (a rise in the supply of money such as printing money or commercial bank credit) to price inflation.

It may be necessary to go further than Krugman suggests, by forcing banks to pay negative interest rates (or higher fees plus zero interest) on savings accounts, and by cancelling all banknotes six months after they have been issued. Even then, Japanese people might not spend their money. Rather they would buy gold at inflated prices.

There may be a Green solution. Just as the European Union paid farmers to be gardeners rather than capitalist producers, the Japanese government could try to attack to Japanese glut from the supply side, by paying producers not to produce. This would have to be complemented by a revolutionary welfare state that would guarantee basic economic security to the Japanese people.

Krugman played down the rises and falls in the value of the yen as being of significance for Japan (they may be significant for the rest of Asia, which is indebted to Japan). Krugman noted that Japan was not an open economy (meaning it is a protectionist economy) and at no stage did he ever suggest that Japan could solve its own problem by turning itself into an open economy. Japan's problem is very simply a lack of spending, relative to a supply glut.

When answering a question about debt as a constraint to the adoption of a reflationary policy, Krugman simply said "Why would a nation in debt want to run its economy at less than full capacity?"

Hence the stupidity of rogermacroeconomics (ie monetarism), or should I say RuthinAsia. The whole fiscal responsibility cult (in New Zealand and elsewhere) is about running an indebted national economy at less than full capacity (ie creating unemployment) as a "responsible" response to high debt. That's about as responsible as a person quitting his job after incurring a large personal debt.

Paul Krugman frequently talks about "crony capitalism" and "collective stupidity" (eg Radio New Zealand, National Programme, 9/8/98). Japan has less of both problems than we do. Yet still Japan is a rich nation in trouble in part because of these two problems. Stupid right-wing policies are adopted not because they are sound, but because they enrich short-sighted capitalists. Crony capitalists follow the slogan (Krugman's words): "heads we win; tails the government loses".

Crony capitalism is about incurring public risk for private gain. I am worried about the Labour Party's "Third Way". A policy of social investment without matching social dividends strikes me as a rather obvious form of crony capitalism. And it was Labour who legislated to make inflation illegal in 1989. Labour is well to the right of Krugman. How could Japan inflate its economy if it was subject to our legislation?



Krugman's Title and Abstract:

Japan: The Future that didn't work

Only a few years ago many people thought that Japan had evolved a business and economic system that was superior to that of Western nations. Then Japan went into its seemingly endless slump, and many peopled decided that Western-style capitalism was superior after all. They are half-right. Japan was never the economic juggernaut of our fantasies. But we are wrong if we think that what is happening to Japan is something uniquely Japanese, or the punishment for Japan's sins. Japan's slump is basically a recurrence of classic depression economics - the same kind of economics that afflicted Western countries in the 1930's. The real lesson from Japan is not that Adam Smith rules, but that John Maynard Keynes remains frighteningly relevant.

Lecture 2: Asia's Great Slump.

Lecture 3: Can it happen to us [eg USA, Europe]?

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