Krugman is right: This is not the time to reverse economic policies

The debate over economic policy has taken a predictable turn, and it's going to be a lamentable one, New York Times (NYT) columnist and Noble Prize-winning economist Paul Krugman says, if we repeat the mistakes of 1936-37.

Just as the critics of President Franklin D. Roosevelt did during the Great Depression, the critics of President Barack Obama's fiscal stimulus package and liquidity-enhancing policies are questioning whether the nation should continue these programs to get the U.S. economy moving again.

In 1936-37, the critics won by harping about inflation. And FDR and his policy makers reversed course. FDR sought to balance the budget in 1936-37 and the U.S. Federal Reserve tightened monetary policy -- despite an economy that was well short of full employment. A liquidity trap ensued, Krugman argues, plunging the U.S. economy back into crisis. The Depression worsened, and full recovery had to wait until increased government spending occurred during World War II.
Japan repeated the error in the 1990s, when their export-oriented economy was showing the first signs of recovery in 1996, by trying to balance the budget too soon via cutting spending and raising taxes. Same error, same result, Krugman says: Japan slid back into recession.

Those who fail to learn from history . . .

Now, you'd think the economic conservatives would learn from history, but they don't, in Krugman's view. Here we are in 2009, and what are the economic conservatives recommending? Economist Art Laffer is warning that the Fed's policies will lead to high inflation. Laffer's recommendation: he wants to raise banks' reserve requirements – exactly what the Fed did in 1936 and 1937 – and exactly what economist Milton Friedman said strangled the budding U.S. economic recovery in 1936 and 1937.

Meanwhile, some in Congress are demanding that President Obama's fiscal stimulus plan be canceled, Krugman noted. The reason? Some Republicans are arguing that the stimulus plan has failed because it hasn't produced Roaring 20s-style growth in four months. Unemployment is rising, the critics note.

Four months. Wow. What patience, by the critics. What commitment. Krugman: Following the enactment of President Ronald Reagan's economic policies in 1981, the U.S. unemployment rate rose for 16 months. Critics need to chew on that economic reality before they venture forth with critiques of the current economic policy.

. . . are doomed to repeat it

Here's the economic reality, according to Krugman: Green shoots have appeared, but it's way to soon to start thinking in terms of 'we need to take actions to slow down the economy.' Inflation is not a problem, at this juncture. Art Laffer is concerned about a rising monetary base, but a rising monetary base isn't inflationary when you're in a liquidity trap, Krugman notes. The U.S.'s monetary base doubled between 1929 and 1939. And prices during that period? They fell 19 percent.

And government borrowing? All it's doing is offsetting a plunge in private borrowing, Krugman noted. Further, interest rates, while they've risen recently, are still low, in historical terms.

Economic Analysis: Krugman's conclusion? A few months ago, the U.S. economy was in danger of falling into a depression. Aggressive monetary policy and deficit spending have, for the time being, averted that danger. Now suddenly critics are arguing we should end both policies, and go back to business as usual. It's way to soon to think in those terms, because the stimulating polices have, at most, just begun to work, i.e. have pulled us slightly back from the rising river. Hence, we should maintain current monetary and economic polices.

And that's my view, as well. Further, to judge the Obama administration's economic policies after four months represents a double standard of the very worst sort: policy makers supported the Reagan administration's economic policies, despite the fact the the U.S. unemployment rate continued to rise for about a year and half following their enactment: the same evaluation standard should be applied today.
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