The Blog

  • May 20, 2012
  • Beginning to End the Great Recession

    Chancellor Angela Merkel of Germany is in trouble.  So is David Cameron, Prime minister of Great Britain though not as much.  Merkel has an election looming and both have been caught on the wrong side of the most important political-economic issue of the generation, the continuing depression and joblessness plaguing Europe and to a lesser degree the United States.

    Economists disagree about what to do.  We often call them political economists in part because their judgments and advice are sometimes couched more in political terms than in the social science of economics.  Thus we have two schools of thought on how to recover from the economic crash.  One school, holding sway mostly in Europe, demands austerity while the other, a mostly American driven idea, call for stimulus.

    So far the stimulus advocates can claim better results and if you read Paul Krugman’s new book, “End This Depression Now” you get the unmistakable notion that additional stimulus could do a lot to pull the global economy out of its tail spin.  So why don’t we all stimulate?  Krugman owns a Nobel Prize in Economics and knows what he’s talking about.  He considers himself a Keynesian after John Maynard Keynes, the mid twentieth century economist who invented, more or less, the branch of economics we call macroeconomics which is the obverse side of the coin from microeconomics.

    It’s difficult to quantify, but if you’ve had any conversations with regular people, as I have recently, you see the two camps run deep.  The Austerians as Krugman calls them want austerity, smaller budgets, increased savings, less government spending.  The Stimulators think this is exactly the time for government to spend money, deficits be damned.  There will be time later, they say, when the economy is back on its feet, to raise taxes and pay for the spending.

    Who’s right?  Each side thinks it is.  And you know what?  Each side is, though only one can be right in the context of today’s economy.  Economists have been famous for this kind of duality, so much so that Harry Truman once got tired of economists speaking to him in the vernacular of “on one hand and then on the other hand,” that he asked his staff to find him a one armed economist.

    But back to stimulus and austerity or macro vs. micro.  The austerity people have a clear idea of how to pull out of a personal economic crisis.  Stop spending more than you take in, pay down debt, save a little and you will be out of the woods before you know it.

    The macro people say that’s the problem.  We’re not dealing with micro or personal economics but with macro, global economies and they operate differently.  If everyone takes the austerity approach spending will decline and the economy will go into a tailspin.  As Krugman rightly points out, my spending is someone else’s revenue and in a big economy that inevitably drives the spending that results in what I call a paycheck.  That’s why when everyone is not spending either the government picks up on spending for a little while or the economy spins down into a deep hole.

    Typically, governments spend on roads, bridges, teachers and other public infrastructure.  They also spend on unemployment insurance.  Unemployed people are a great investment because you can count on them to spend the money they get and spending is what spins an economy up.  Also, in a recession, with construction at low levels, government can get these things at bargain prices again putting money into the economy.  And if you buy productive assets like infrastructure, you have these things to work with as the economy improves.  Government spending is like training wheels, soon you don’t need them and you ride off on your own.  Think of this as investment.

    Unlike the U.S. the Europeans have a small problem with infrastructure spending or any other kind of spending.  The spending, if it happened, would occur with German money in non-German countries so the Germans are reluctant to try this approach.  That’s the problem of having a unified currency but a non-unified government where each state is sovereign.  There is also more than a touch of righteous moralizing going on by the haves over the have-nots.

    The German conundrum notwithstanding, there is a huge body of evidence from studying the Great Depression of the 1930s onward that shows government spending drives recovery from severe economic crashes.  The body of evidence also shows that failure to spend simply deepens the hole everyone is in.

    Krugman and his colleagues would have liked it if the U.S. stimulus had been bigger or if multiple tranches of stimulus had been applied.  The people who say stimulus doesn’t work are the same ones who denied further spending and fought against the original stimulus plan.  All that is water under the bridge.  A kind of social experiment has nonetheless been performed and the economy that was stimulated, even inadequately, is doing much better than the economy with the brakes on.

    If that’s not enough, what Merkel sees is that the French just elected Francois Hollande, a Socialist who promised to focus on stimulus and job creation in diametric opposition to Nicolas Sarkozy, a Merkel acolyte.  So we were treated to a delicate face saving about face by Merkel this weekend when the leaders of the G8 convened at Camp David with the unofficial goal of convincing Germany that austerity isn’t working and won’t.

    Merkel really likes her policy and is not going to change her mind easily.  But with that election looming, she is at least now saying that austerity and job creation must go hand in hand.  Such is progress in international politics.  One wonders how much faster things would go if Merkel had a chance to see first hand how her policies are affecting millions of people.

    Published: 6 years ago


    • May 23rd, 2012 at 6:44 am

      Hi Denis,

      we are closer to each other than my deliberately provocative first post made it seem.

      I agree that investment into infrastructure is positive, given that the benefit also reaches the work force and not only the capital. Call me a socialist (which I am not) but this does not happen sufficiently. Those who have are given more and the others struggle.

      Money is not an infinite resource, unless its value is 0. If you devalue the currency then the consumers will be hurt because imports will be more expensive. Companies will compensate by raising prices. Salaries/wages will not keep up that pace. Interest rates will go up with the effect that those that have will get more.

      On an economical scale the USD will lose importance and be replaced by other currencies.

      Country economics are interdependent; we do not fully understand the impacts of actions anymore.

      The German constitution says in paragraph 14(2) “Property entails obligations. Its use shall also serve the public good”. This i something that all of us, including Germans, should look more at.

      This is also the reason why I think that bank loans as they happened in the US and in Europe are a stimulus that didn’t work. Banks and rating agencies are the ones that decide the fate of a company or country (if in debt). This unluckily often happens only after the proverbial s… hit the fan. They haven’t been held accountable and that is why they are continuing as before.

      Consequently, for countries as well as for for companies or individuals it is important to be able to pay back the debt. Inflation and the money press do not help in that respect if credibility shall be retained.

      And yes, the EU have a genetic deficiency, which imo has its roots in pride and greed.

      All this might open yet another can of worms …

      Thanks, for your thoughts!

      • May 23rd, 2012 at 7:21 am

        Hi Thomas, I certainly agree that runaway inflation is bad and to be avoided, but single digit inflation is a normal part of a healthy economy and 4 percent is rather tame. so inflation has a place in modern economics, without it or with deflation loans would be much harder to repay and then the rich wild really make a killing because borrowers would be paying back greater values than they received. Also, the infrastructure in the US is so bad that some targeted spending would be worthwhile in its own right.

        your analysis is, I think, good, but it doesn’t take into account the risk premium that interest rates cover. People lend at interest to cover the risks that money repaid will be worth less than what was loaned. Inflation balances risk premium for the borrower. Also, if you expect the rich to put their money to work, I.e. at risk, then the reward has to be greater than the security of a government bond in a low inflation environment. We have a lot of cash on the sidelines that will not go to work unless it is less risky to do so than holding on to it. a bit higher inflation tells smart money to get to work, off the sidelines.

        the US banks got loans from the Federal reserves to stem short term cash flow problems caused by losses I derivative markets. These loans were repaid so I don’t regard them a stimulative. That’s my opinion.

        I am not a socialist either but I wouldn’t mind a society in which there was greater economic equality!

        Part of me doesn’t object to the Germans no wanting to find. Greek, Italian etc. recklessness but the other part of me says this is not a morality play and that sooner or later Germans will discover that they have no one to trade with. Germans are focusing on their short term interest in my view rather than the long term. I know that Keynes said in the long run we are all dead but i worry about the world I am leaving to my kids.



        Sent from my iPad

    • May 22nd, 2012 at 7:11 pm


      thanks for your reply.

      I do not have a wordpress account (and do not intend to create one 😉 ) – that’s why I need to break the chain of discussion here. Sorry for that.

      Yes, no one wants to win the race of being sickest – lets just agree that both parts of the world are very sick economically. And this is probably because of a sick economical model.

      France has changed its opinion because promising the good to everyone just wins you elections. Let us see where Hollande ends up when realities really hit him. And on a small scale he already started austerity by cutting ministerial salaries. But then: Why do they need 34 ministers?

      There are a couple of more nations which had or have a surplus. Until recently Norway belonged to these countries, too, Iceland until their banks broke, Ireland was there, too, until, well, we all know until when …

      So, yes, my comment was too strong. As for the US George W Bush had all chances to achieve a surplus as well, and didn’t (like G. Schroeder or A. Merkel in Germany).

      It is true, I wrote that stimulus, didn’t work – and it didn’t, because the US ran out of money to stimulate enough. This is probably because of lots of mistakes done in the past, interconnected national economies, and the stimulus just being poured with the watering can instead of better focusing it.

      I think it was a good move to support GM, btw.

      Maybe it meanwhile was even a necessity to first give even more to the ones who caused most of the problem: The (investment) banks, which one continually fails to reign in (because they are contributing so much to the politicians’ campaign funds?) – but then I am not a Nobel Prize winner, not even an economist ;-).

      So, I stick to my words: Stimulus doesn’t really work; because it needs to be too big to be affordable. It is like an addiction that has gotten out of control. Besides, for a stimulus to work one needs to be fully rational, take all emotions, like e.g. greed, out of the picture. People do, and will continue to do, what is best for them. In the current situation this is not necessarily what is best for the rest of us.

      Look what happened to the 3 billion Euro that the European Central Bank took into its hand to stimulate. A hell of a lot of that money right away moved back to the ECB and got parked instead of being used to keep inter bank money lending up. US banks that got significantly funded are doing better than before and even got the chance to socialize many risks that they have taken up (same for the European banks).

      Further, the current neo-liberal thinking bases upon the thought that everyone’s negotiation power is equal. This is unluckily not true and that is a fundamental flaw of the theory.

      I also agree that a complete austerity approach does not work. Greece is the best example for this. They are currently starving themselves – but then decades of corruption and lies cannot be cured within a few months.

      So, where does this leave us? Focused stimuli, enforcing accountability, breaking entities that are too big to fail, austerity at the right places. This seems to be a good combination to me.

      Still we need to overcome the growth at any cost mentality.

      Enjoying the discussion

      • May 22nd, 2012 at 8:45 pm

        Hi Thomas,

        there is a lot to agree with in what you say. For the record, I don’t lump bank bailouts with stimulus and I may be wrong but I don’t think the wise guys do either. In the US there was a separate loan facility for banks that is mostly paid back already. The stimulus was separate and went to infrastructure projects and targeted tax cuts. I agree with you on targeting. In the US our public infrastructure is rated near failing (D+) by the. American Academy of Civil Engineers, so there’s plenty of worthy projects to spend money on that would benefit the economy. At the state level we’ve experienced austerity because states are not allowed to run deficits. A million Teachers have been put out of work and simply bringing them back would have a great stimulative effect.

        I do disagree with the notion that stimulus doesn’t work because it is unaffordable. It has to be evaluated on its merits not on affordability because any sovereign nation with its own currency can print enough money. The issue is the debt to GDP ratio which would get out of whack for a time but inflation and even paying down the debt fixes this. The alternative is suffering because we’re too cheap to do the right thing which doesn’t make any sense to me, personally. In what is supposed to be a democracy–government by of and for the people, that kind of cheapness, call it austerity’ makes no sense to me. We can do better.

        Finally, the EU is a slightly different kettle of fish due to the sovereignty issue and the shared currency, but it is still amenable to a stimulus solution. The alternative has been tried and found wanting.



        Sent from my iPad

    • May 21st, 2012 at 10:12 pm


      a few questions:

      is Europe sicker than the USA? There are a couple of sick countries, admittedly. From where I am (NZ, but German) the USA are in the emergency room – without knowing it. As you said: Stimulus just didn’t work so far either, as evidenced by ever increasing budget demands and a situation where ever less people have ever more money and the rest gets less and less … Apparently those who get stimulated do something with the stimulus – ok, lets call it what it is: Money – that is good for them but not for the what is around them, their neighbours, country, ecosystem.

      Next question: Is there any evidence that politicians EVER save the money when economy is up and running? There isn’t. And the next election is always looming, which calls for additional spendings into the own interest groups aka lobby groups.

      Where does this leave us? Apparently neither approach doesn’t really work. Looks like it is time to fundamentally rethink the overall ecosystem we live in …


      • May 22nd, 2012 at 8:00 am

        Well, thanks for reading and for your thoughtful reply. Let’s take the questions in order.

        Who is sickest, EU or US? This is a race no one wants to win. But I’d give the trophy to Europe. They have a currency union that could fall apart with huge damage to the global economy and sky high unemployment in more than a few sick nations. Even France, until recently one of the Austerity club’s main members, has employment issues. The UK, not a member of the Euro, Spain, Portugal, Italy Ireland and of course Greece are all off the charts with unemployment. Studies show that at this point in the Great Depression employment had started to improve in places like the UK but not this time.
        I don’t think I said that stimulus didn’t work, I think I said that there wasn’t sufficient money to make it truly effective. Again, the experts such as Krugman and others laid it out this way. US economy $15trillion, needed propping up for three years — meaning $45trillion in economic activity — so we tried to do it with $780 billion. We got some very positive signs but then the money ran out and we have what we have. By the way the US unemployment rate is 8.2 percent last time I checked.
        I agree that the lopsided distribution of wealth and income between the 99 percent and the 1 percent is an issue. The numbers we see today were last sports before the Great Depssion. It’s not healthy for the ecosystem.
        Next, politicians saving money. Yes, I can document at least two situations. The Truman administration just after WWII and Clinton ran several surpluses which went to pay down national debt. If we had tax rates on marginal income like we did in the 1990s we’d be better off. As I wrote here yesterday if the choice is between taxation and investment money flows to investment. That happened in the 90’s and resulted in a huge boom. I’d say that government doesn’t really even want the marginal taxes, just the economic activity that investing those monies into the economy provides.
        And anther point is useful to consider. Inflation. We’re currently running at a rate of about 2 percent in most places. Raising inflation to 4 percent would be helpful to spur the economy and it would not be detrimental to the 1 percent either. Inflation makes national debt easier to manage because it helps to reduce the ratio of GDP to debt. The sooner that happens the better.

        Finally I must disagree with you on your last point. A stimulative approach works and is good macro economics. It has worked before and can work again. The austerity approach applies microeconomic solutions to macro problems and is doomed. There is plenty of evidence to support this and if we were all dispassionate social scientists we could look at the data and draw that conclusion. Einstein said repeating the same activity expecting a different result was the essence of insanity. We have been pushing on the austerity string long enough.

    • May 21st, 2012 at 2:04 pm

      I am not sure I can agree with you on some points.

      First, and this seems to be over looked by many, what you spend money on is perhaps more important than the amount you spend. OMB has plenty of data that says spending on productive assets which causes people to spend paychecks is a great thing. Borrowing money to spend on a war is at the other extreme so why not do more of what’s known to work?
      We have a roughly 15 trillion dollar economy that needed three years of stimulus to avoid the recession. We spent $780 billion to support the marginal needs of $45T in economic activity. I can’t say that was sufficient stimulus.

      The issue with rewriting the tax code is twofold. First it assumes there’s something to tax, no taxes are paid if there isn’t economic activity to tax. So you can say that while cutting taxes is a good idea it is something for later in a recovery cycle, not the thing to do to prompt a recovery.

      Second, taxation is one of the few levers we have to make course adjustments in the economy. Regulations are another but they are largely of the “Thou shalt not” variety. Tax code gives pinpoint breaks to specific things that are to be promoted. So I like the idea of tax reform but I think it needs to be done surgically not in a big bang of throwing out the rule book. We tried that with deregulation and it didn’t work so well. I like the tax code even more just the way it is because it actually mimics a real ecosystem and in ecosystems complexity is good, simplicity bad. A farm is a very simplified ecosystem with one or a small number of participants. When one plant or animal gets a disease all get it because there are no natural fire breaks as there are in the wild. I think of the economy that way.

      As far as investment is concerned, I take note of the lesser risk theory. Money goes where it is treated best and where there is less risk. During the Clinton administration taxes went up to cover expenses and everyone said it would tank the economy but just the opposite happened. The reason is simple. Hanging onto money was more risky because of tighter tax regulations, than investing it in startups. The late 1990s saw the greatest infusion of money into investments in new technologies (primarily the Internet) in history. In 2000 more than $100 billion was invested in VC money. Today that number fluctuates between $20 billion and $30 billion annually. If you really want to see a boom in investing, raise taxes on the rich. They’ll get richer and will thank you.

      Finally, energy. Pumping oil is not a political issue, or at least it shouldn’t be. Money on federal lands belongs to all of us and is being saved for things like aviation fuel in the event of war. are you sure you want to give it to the big oil companies? There is estimated to be 910 billion bbls of oil left in the ground, including the ground under the ocean. The US has raised its production from 4.95 million bbl/day to 5.75 Mbbl/day but we consume 19.2 million. We have a very long way to go to reach export status and estimates are not encouraging that we will ever get there. At the peak of the last decade when we were pumping 4.95 mbbl/d we were consuming 20.9 mbbl/d so the recession induced conservation has done as much to improve our energy outlook as drill baby, etc. In short, we are not going to become an energy power unless we start generating more electricity which given the nature of electricity will be for local markets.

      Last point, if austerity really worked at a macroeconomic level, why aren’t there any success stories in the world today? Why is Europe sicker than the US? Why didn’t Herbert Hoover fix the Depression in his four years?

      • May 22nd, 2012 at 1:46 am


        You can make all those rationalizations. But you cannot argue with the facts of total, singular, and cataclysmic failure, which is the Obama administration economic record. Millions and millions of Americans put their faith in this man, and he has failed them completely. Categorically. Absolutely. He promised them better. And he hasn’t delivered. Case closed.

        • May 22nd, 2012 at 7:27 am

          I guess we’ll just keep separate ideas on this one. I don’t think the characterizations of “rationalization” are fair though. I like to think I presented a logical argument backed up by experts. There is no doubt that Obama has disappointed though. However, when one whole party publicly dedicated itself to his failure, putting its interests above the nation, I think we’re beyond economics which is what I was focused on. Next time try decaf!

        • May 22nd, 2012 at 10:52 am

          When did this become a political conversation. I was so enjoying the macroeconomic discussion and then next thing I see is that this president [has not] done this; this political party did that; and, that all of those who serve us get elected and make decisions ONLY with the next election in mind.

          Bottom line there is a time for stimulus and a time for austerity and a time to do nothing. 2001 was a time to do NOTHING to taxes. Should have just left well enough alone. 2003 was a time to ‘go to war’ but we should have figured out a way to pay for it first. The second war – same; and, when it came to Prescriptions there should have been a way to pay for that as well. That all happened between 2000 and 2008. At the same time regulations that might have; not necessarily would have were lifted that precipitated a MAN MADE economic crisis that could have been totally avoided.

          So, like I said there is a time for stimulus (NOW); a time for austerity (2003 through 2008) and a time to do nothing. Read into it what you want but there are so many reasons (G) needs to spend to goose this economy and prepare us for its recovery that to make the argument otherwise .. well; that is ridiculous. Case closed !!

    • May 21st, 2012 at 12:56 pm


      I think Krugman’s characterization of the “Austerites” misses the point. And as he is a Nobel-winning economist (ha!), I believe he does so deliberately.

      GDP = C + I + G + (X-N)

      G = Government spending, which is only 1/3 of the economy. Government Spending cannot responsibly be increased further, because we already are at UNPRECEDENTED levels of debt-spending. We’ve tried stimulus for four years, and it hasn’t worked.

      The Austerites want Growth as much or more than the Spendthrifts (as I call them) do, we just want to see it through increases in the other parts of the economy: Consumer Spending, Investment, and Net Exports.

      So let’s try increasing Consumer Spending by rewriting the tax code to cut loop-holes and reduce marginal rates; let’s increase Investment spending by removing regulations and taxes that discourage investment; let’s increase Exports by signing free-trade agreements and reducing trade barriers; and let’s decrease Imports by removing barriers to domestic manufacturing and energy production (energy production from federal land is down significantly under Obama).

      This recession would NOT have been the worst recession since the Great Depression if we had done all this. Arguably the 1982-84 Recession was worse in terms of the height of unemployment, but it didn’t last as long because we did the right things instead of the very wrong things.


    • May 21st, 2012 at 11:31 am

      There is more to the infrastructure argument as well.

      Roads, railways, bridges, ports, border crossings, airports, and other potential ‘bottlenecks’ of raw and sometimes finished materials are ADDING cost to our economy just when we need less friction between manufactured good to consumed product. These bottlenecks were disguised during our ‘Great Recession’ but will slow us down significantly during recovery if the government doesn’t get off its ass and begin CREATING JOBS by improving infrastructure in the United States.

      See today’s USAToday: “Infrastructure Hold Back Economy”

      Rather than look at the debt crisis (of which I absolutely agree there is one) as a crisis …. we need to look at it as an opportunity; the beginning of a virtuous cycle by which we can reduce the bottlenecks in our economy, create jobs (long term well paying jobs), increase tax revenues by adding workers and decrease costs by laying out less unemployment insurance, and increase investment in a environment whose hallmark is the lowest interest rates since we all have been keeping records.

      So why can’t the Austerians realize that NOW is the time to be a STIMULATOR. There will be plenty time to enact austerity once we are on our feet.

      Just my 2 ‘sense’ !!

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