Krugman: Governments Are About To Make The Dumbest Mistake Ever--Cutting Back On Spending And Killing The Recovery

As the rest of the world works itself into a panic over debt and deficits, Paul Krugman continues to argue that acting on this fear will quickly make things far worse:

What’s the greatest threat to our still-fragile economic recovery? Dangers abound, of course. But what I currently find most ominous is the spread of a destructive idea: the view that now, less than a year into a weak recovery from the worst slump since World War II, is the time for policy makers to stop helping the jobless and start inflicting pain…

Both textbook economics and experience say that slashing spending when you’re still suffering from high unemployment is a really bad idea — not only does it deepen the slump, but it does little to improve the budget outlook, because much of what governments save by spending less they lose as a weaker economy depresses tax receipts. And the O.E.C.D. predicts that high unemployment will persist for years. Nonetheless, the organisation demands both that governments cancel any further plans for economic stimulus and that they begin “fiscal consolidation” next year.

We follow Krugman’s logic there. And anyone who argues that we should cut spending instantly without acknowledging that this will cause major short-term pain is either delusional or disingenuous.

But to make his case more persuasive, Krugman needs to explain why Niall Ferguson is wrong that, once government debt hits about 90% of GDP (where ours is headed), default is pretty much inevitable. 

Pointing to the post-World War 2 experience, when US government debt soared and then shrank gradually as a per cent of GDP over the next two decades, doesn’t take into account the massive consumer and financial debt the country currently carries.  In those days, it was just the government that borrowed up to its eyeballs.  Today, as shown in the chart below (total debt to GDP), we’re in completely uncharted territory (and this chart is now more than a year out of date…).

See Niall Ferguson’s argument here >

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.