Paul Krugman commented early this morning on the Wall Street
Journal oped by John Cogan and me. Our
oped is based on our research paper with Volker Wieland and Maik Wolters which shows that
there are beneficial effects on the economy—in the long run and the short
run—of a ten-year program to reduce the budget deficit, and eventually balance
it, as proposed by the House Budget Committee.
Krugman’s claims about this research are wrong.
He complains that we get these results “because confidence!”
But we never mention confidence in the oped or in the research paper
with the simulation results. Our model includes concepts like the permanent
income hypothesis, incentive effects, and of course people taking expectations
of the future into account when they make decisions
Krugman claims that we are unfamiliar with research by “Mike
Woodford, who they appear never to have read.” In fact, the research paper by Mike Woodford,
who was the co-editor with me of the first Handbook of Macroeconomics, refers
to our modeling research and we in turn have referred to his paper in
subsequent research (pp. 85-114). Moreover, the
research of ours that Woodford refers to was validated by many researchers at
central banks and international financial institutions.
Krugman disagrees with our statement that “resources to
finance government expenditures aren’t free—they withdraw resources from the
private economy” saying this isn’t so in a depressed economy. But the whole point of our simulations is to
show how a gradual and credible fiscal consolidation will help get the economy
out of its depressed state and into an economic situation where people
recognize that lower growth of government spending eventually means lower taxes
and more take home income.
The paper by Woodford that Krugman refers to uses
expectations, as we do, but that paper is about a completely different policy
question. As Woodford says he considers
“only the consequences of temporary variations in the level of government
purchases.” In contrast, in our Wall Street Journal article and our research on
fiscal consolidation we consider the effect of permanent changes in government
spending which are phased in over time to bring the budget deficit down.
Not mentioning this crucial difference, Krugman goes on to claim
that we get our results because “we have slipped in some assumption” and then
guesses what that might be. In our oped, we summarize the assumptions and the reasons for our result that the plan is good for the economy, and a higher
interest rate is not one of them.
