Krugman and “Fiscal Scare Tactics”

I don’t like to start fights with Nobel prizewinners in economics, especially with one who is usually right, but I have a bone to pick with Paul Krugman on the topic of “fiscal scare tactics.”

For months now, Krugman has argued that Republicans and their lapdog followers in the press have been hyping the dangers posed by soaring federal deficits and debt.

“There’s no reason to panic about budget prospects for the next few years, or even for the next decade,” he wrote in his Times column on February 4. Given the magnitude of this recession, Krugman argues, we absolutely should be running huge deficits in order to prevent an even bigger cataclysm.

Last Friday, Krugman followed up with a post on his blog entitled “Debt is a political issue.” There he explained that the Federal debt, now approaching 60 percent of GDP, wouldn’t pose a huge burden even it jumped to 100 percent of GDP. After inflation, the Treasury’s real interest rate is only about 1.5 percent.

If you do the arithmetic of debt service, that really does seem to suggest that debt isn’t a problem….All the government has to do is pay the real interest on it. So suppose that we add debt equal to 100 percent of GDP, which is much more than currently projected; servicing that debt should cost only 1.4 percent of GDP, or 7 percent of federal spending. Why should that be intolerable?

Now, I agree with Krugman’s broader arguments. No serious economist thinks it would be a good idea to slash spending and deficits yet. At best, that would choke off the feeble recovery. At worst, we would plunge back into a deep recession.

I also agree that Republicans, most of them latter-day converts to fiscal piety, are hypocritically whipping up hysteria to advance two dubious goals: 1) discredit President Obama, even though he inherited today’s mess from Bush; 2) attack Social Security, Medicare and Obama’s health care reform as threats to freedom-loving Americans.

But Krugman doesn’t stop there. Perhaps because he’s convinced this is a political battle, he resorts to gimmicky arguments to make a simplistic case that there really isn’t much of a deficit problem at all.

As a result, I think he undermines his credibility by sounding like a propagandist rather than the truth-teller he usually is.

Full disclosure: Krugman attacked an article that I wrote on the “debt bomb’’ in the New York Times back in November. He called it “alarmist’’ to write about the projected surge in interest expense to $700 billion a year by 2019.

But I’m writing today about two more recent pieces. On February 4, he explained why there was “no reason” to panic about the budget for the next few years “or even for the next decade.”

His evidence? The White House projection of $700 billion in annual interest expenses, 10 years from now, would equal only 3.5 percent of G.D.P. “How scary is that?” Krugman wrote. “It’s about the same as net interest costs under the first President Bush.”

Well, no, it’s not even close to the same. Under Bush, that debt burden occurred when the US was just crawling out from the back-to-back recessions of 1990 and 1991. As Krugman would say, that’s exactly when you would want big deficits and, if necessary, high interest payments.

By contrast, the interest-expense projections we’re talking about here — which come from the White House and CBO — are for 2020 and assume that we will have enjoyed TEN YEARS of steady economic expansion. That’s exactly when you’re not supposed to have high deficits.

On Friday, Krugman made another dubious comparison. This time, he threw up a chart showing that the United Kingdom’s public debt shot up to 250 percent of GDP during World War II and then plunged back to normal levels after 1950.

If it worked for the Brits, it ought to be fine for us too, right? No, and for a similar reason as before. In 1950, the British economy had been bombed almost to oblivion. By definition, the debt-GDP ratio was incredibly high because GDP was incredibly low. With the war over, GDP had nowhere to go but straight up. It was the absolute perfect moment to have high debt.

The United States is in almost the opposite situation. Our debt is now approach 60 percent of GDP and it could approach 80 percent by 2020. But again, that would be after 10 years of steady growth.

To cement his case, Krugman also argued on Friday that the Treasury’s cost of borrowing is incredibly cheap. Real interest rates on 10-year bonds, after adjusting for inflation, are only about 1.5 percent. What’s so scary about that?

The trouble, of course, is that interest rates are heading up. If everything goes perfectly and the economy recovers without a surge of inflation, the betting is that nominal 10-year rates will top 5 percent in a year or so — 3 percent, if you stick with “real’’ rates and discount for inflation.

The outlook gets a lot uglier if things don’t go so swell. If foreign investors get nervous, or inflation expectations come unhinged, or the rating agencies knock down the U.S.’s AAA rating, it’s anybody’s guess what kind of a risk premium gets attached to US borrowing.

Krugman admits this. “If bond investors start to lose confidence…. they’ll demand higher rates, which requires much larger primary surpluses, and you can go into a death spiral.”

That’s what worries a lot of smart people who aren’t Republican charlatans but are worried about deficits. They don’t want to slash this year’s deficit or next year’s. They want to see a credible gameplan over the next five to ten years for regaining control over what the CBO flatly describes as the current “unsustainable’’ trend.

I have to believe Krugman thinks the same thing. But because he’s so worried about Macchiavellian fear-mongering by Republicans, he ends up sounding less than honest himself.

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