Paul Krugman educates me

Link via Matt

I'd always disagreed with liberals on how to interpret FDR's decision in 1938 to cut back on spending, which plunged us back into depression. Liberals interpret this to mean that the economy was going much better and then FDR cut spending and it just went down hill. The lesson? Never cut spending, I guess. The lesson I drew is that stimulus is worthless except as a means to alleviate some pain. It's a pain killer for the economy, not a cure. It's not like FDR could just spend forever and bankrupt the country. It also proves that FDR didn't fix the economy at all. He just put it on life support, and as soon as he pulled the plug, vital signs crashed again. Which is entirely predictable in hindsight: FDR's team hadn't a clue about economics. They'd bought into Keynes theory too much.

But what I didn't understand is why if the New Deal failed why did WWII succeed? Was it more spending? Yeah, it was, but why would that bring the economy back? It's still just government spending propping things up, and because of the war there was no growth in the private sector since it was mainly churning out stuff for the War Dept.

Thankfully, Krugman finally answers the question:

Absent a strong demand for exports, the most plausible way for a country to crawl out of this kind of recession is for households to keep paying off debt until they can afford to spend again. Indeed, as Paul Krugman argued in a recent lecture series at the London School of Economics, the reason the United States didn’t slip back into depression after World War II–something many economists feared at the time–is that, 15 years after the initial crash, people had finally put their finances in order.


And that's why current stimulus plans aren't going to accomplish squat. The economy needs to deleverage first. Since the most leveraged people are people who actually pay taxes, tax cuts would serve to speed deleveraging better than anything else, despite the fact that tax cuts have a lower multiplier. But fixating on multipliers misdiagnoses the problem. Growth is great, but growth driven by public spending won't solve much. We need to deleverage, and giving people more of their money back instead of burdening them with high taxes would speed that process along faster than giving more public jobs to workers who aren't leveraged that much to begin with.