One of Paul Krugman’s constant themes has been that “austerity” is the wrong prescription to deal with a shrinking economy. If the economy is going south, he claims, then governments must spend and spend prodigiously in order to prop up everything. (Krugman adds that this should be the case when the economy is in a “liquidity trap,” which he believes changes the rules of economics.)
At one level, I understand his point. The “austerity” programs often mean increased taxes and other government activities that can drag down an economic recovery (although Krugman has been insistent that we need massive tax increases in the USA, so I don’t know why he would be against that aspect of “austerity”).
Yet, there is something else out there, something that really divides the Keynesian and Austrian camps: Keynesians really believe that spending money is what creates wealth, and that governments can create wealth out of thin air simply by cranking up the spending. Furthermore, assets really are not real; if the economy goes into the tank, government simply can declare prosperity and if people believe (yes, only believe) that the spending will make everyone prosperous, then all is well.
How else can someone really claim that heavily-subsidized industries like “wind power” and “corn-based ethanol” can create overall prosperity and lead us into recovery. How else can someone really claim that if government takes enough resources away from everyone else and gives them to GM, Chrysler, and the United Auto Workers, that we will have overall prosperity?
Austrians do not see “austerity” as a policy, but rather a reality. This is not a morality play (even if Krugman has accused us of enjoying the infliction of “pain”), but rather a bowing to reality of the fact that one cannot fix a broken economy by pretending it is not broken.
There is something else I have noticed; in Krugman’s view, if a policy has immediate “good effects,” then the policy must be good. Thus, ANY liquidation of malinvestments also must be bad, bad, bad, as that means short-term pain.
It was not just the Keynesians who have demanded that we play a “let’s pretend” game about the economy. Shortly after the financial crisis of the fall of 2008 became painfully obvious, Martin Feldstein, who was President Ronald Reagan’s chief economic adviser, called for the government to enact what was little more than a scheme to prop up housing prices. Like the Keynesians, Feldstein could not recognize that falling prices were a symptom, not a cause of the larger problem.
In the Keynesian world, there are no malinvestments, only idle resources. Spend enough, and those resources will rise up. After all, doesn’t Y = C+I+G+(X-M) tell us everything we need to know about the economy?
Well, not it doesn’t. In fact, I will go as far as to say that the equation tells us next-to-nothing about an economy and how it works. The economy is not in recession because there is a lack of spending; there is a fall in spending because the economy is in recession, and we cannot spend ourselves into prosperity no matter what Krugman and the Keynesians tell us.