Krugman: balanced budget would be “worst thing for future generations”

Last week Left Foot Forward showed how UK business investment was in a state of collapse. The US is suffering the same problem and Nobel prize winner Professor Paul Krugman has written about the necessary policy response on his ‘Conscience of a Liberal’ blog.

Krugman writes:

“Under the kind of conditions we’re now facing, the main determinant of business investment is the state of the economy, as evidenced by the plunge in investment shown in the figure. This, in turn, means that anything that improves the state of the economy, including fiscal stimulus, leads to more investment, and hence raises the economy’s future potential.

“That is, under current conditions deficit spending doesn’t lead to crowding out — it leads to crowding in. In fact, you could argue that the worst thing we can do for future generations is NOT to run sufficiently large deficits right now.”

The argument undermines the key tenet of a speech made by George Osborne on September 15th when he argued:

“in an open economy [reducing the deficit] does not undermine recovery by reducing aggregate demand.”

Rory

When you say ‘undermines’ you presumably mean ‘is at odds with.’ Do you think that if Mr Krugman disagrees with an argument, he automatically undermines it?
Howard Reed

Well said, Paul Krugman. The UK is in danger of repeating the mistakes of the early 1980s, when aggressive tightening of fiscal and monetary policies led to the worst post-war recession (until the current one) and increased unemployment to over three million.

George Osborne’s speech is extremely confused. On one hand he says “well targeted fiscal stimulus could be a sensible part of the policy response to the recession” (if the funds were available) but then he says IMF research shows “fiscal policy is powerless to affect output in open economies”. So which is it, George?

If we’d followed Conservative policy recommendations so far in this crisis, we’d be in the same mess as Ireland…
Oikonomist

What works in the US won’t necessarily translate to the UK.

The US has a reserve currency, Britain does not. The Pound is the weakest major currency in the world right now, partly because people fear that the deficits are not under control and the QE/money printing schemes have no end in sight. People see inflation around the corner.

Inflation and an ensuing hike in interest rates will reduce business investment and reduce Britain’s long term prospects.

This is a more subtle argument than copying Krugman’s test implies. There’s nothing wrong with a deficit but the problem is that the UK has been running one for a long time, Brown even broke his own “golden rule” when Chancellor. We could run a much bigger deficit and have a real (rather than a meek) fiscal stimulus if the public finances were stronger.