Krugman Misreads Data Proving Paradox of Thrift

I'm seriously beginning to think that Krugman doesn't care about making sense any more. Instead, he'd rather use vaguely economic-sounding arguments and cherry-picked statistics to support his normative priors, and then scream "Treasury View! Treasury View!" whenever somebody questions him.

Earlier this week, Krugman willfully misread a graph in order to argue in favor of a second stimulus. In yesterday's example, Krugman misreads the graph below and says that it shows incontrovertible proof that the Paradox of Thrift is real, therefore Keynes was right, therefore Krugman is right, therefore we should have a second stimulus. Look at the graph:


What does it show? It shows that net national saving has gone down since the recession began. This is what an advocate of the paradox of thrift would predict. But why has it gone down? Because the government has spent a ton of money! Personal savings are way up, and corporate savings are only down a small amount (likely due to reduced investment caused by excess inventories and the credit crunch; this could reverse within the next few quarters) and not nearly enough to offset the rise in personal savings. If you take the government out of the picture, then net national saving has gone up and the paradox of thrift is wrong.

Of course that's a huge "if". It's not clear what the personal savings rate would be if the government were not spending in deficit. But Krugman rejects the rational expectations story (Treasury View!) that individuals react to government deficits by saving for future tax increases. If that is true, then the reverse must be true as well: individuals should not react to fiscal neutrality by lowering savings. And if that is true, then the above graph actually shows that in the absence of government deficits net savings would still go up, so the paradox of thrift is wrong, Keynes is wrong, Krugman is wrong, and the case for a second stimulus is weakened*.

Krugman can't have it both ways: either people alter their behavior in response to government deficits or they don't. If they do, then the stimulative effects of deficit spending are at least partially offset by reduced demand from individuals (Treasury View!). If they do not, then the paradox of thrift does not exist in the present situation.

Like the Laffer Curve, the paradox of thrift is definitionally true at some margin. But it is not clear that we are at that margin or even anywhere near it.

*Though not destroyed; personal consumption is still negative, so Krugman could still argue that stimulus is needed to boost aggregate demand. This demand-side argument is the crux of Keynesianism. But the supply-side argument doesn't support his case, and actually works against it since some of the demand-side effects will be negated by supply-side responses.

Comments

[TracingError:]

You clearly do not understand the paradox of thrift. It states: the economy turns bad, and the savings rate goes up. If people save, then there is no basis for recovery in a consumption-driven economy.

That's what the graph shows. That's your big "a-ha"--that without the government, saving has gone up. And that's the entire point of counter-cyclical government spending.

Jul 09 09:34 AM

[TCK:]

As you say, Krugman starts out with his politically motivated conclusions then interprets the data to support it.

Jul 09 09:57 AM

[jaume ribe,...:]

I'm surprised at how the concept of rational expectations holds on.
Of course Prof. Krugman knows what he is talking about

Jul 09 11:41 AM

[Kindred Win...:]

Tracing -

I'm not wrong at all, and I perfectly understand it.The paradox of thrift states that if people save in a recession and aggregate demand decreases, then total *savings* will also decrease because of the lessened economic activity. The paradox of thrift is not so much about recovery but about savings. Which is why it's a paradox.

Jaume -

My point wasn't that rational expectations was right or wrong. It was that Krugman is trying to play it both ways as it suits him -- citing rational expectations at some points and denying it at others -- and that that is intellectually dishonest. Of course, an intellectually dishonest person may know what they are talking about but willfully ignore it. Which is what I think Krugman is doing.


On Jul 09 09:34 AM TracingError wrote:

> You clearly do not understand the paradox of thrift. It states:
> the economy turns bad, and the savings rate goes up. If people save,
> then there is no basis for recovery in a consumption-driven economy.
>
>
> That's what the graph shows. That's your big "a-ha"--that without
> the government, saving has gone up. And that's the entire point
> of counter-cyclical government spending.

Jul 09 01:38 PM

[Gregman2:]

Not sure about your reference to the Laffer Curve (unless by it you meant erectile dysfunction). Perhaps the more important question is: what harm might a second stimulus have?

Jul 09 03:01 PM

[W.E. Heasley:]

Great article. Great points.

Agree with you that The Laffer Curve and the Paradox of Thrift are applicable at some margin.

Further agree with you that Krugman fits data to suit his Political Economy.

You mention Krugman’s propensity to “cherry pick statistics” .

Krugman’s “cherry pick” can clearly go one level further. Of all the lessons learned through empirical economic studies of the Great Depression, Krugman seems to always, and conveniently, fail to mention Federal, State, and Local taxes increased during the Great Depression hence stifling Private Capital Formation and hence stifling Private Sector job creation.

Moreover, a Neo Keynesian Theory that has persisted for years is: the reason the Great Depression continued for years on end, with persistently high unemployment, was because the Keynesian Government Deficit Spending was not large enough. That is merely a “theory”. There is no conclusive empirical data to back up the theory. However, at the end of the day, this theory is Krugman’s basis for the second stimulus.

Finally, Krugman never mentions the current background of Simultaneously Deploying Keynesian Deficit Government Spending and QE, in an environment of current high Government debt. One must realize that both Keynesian Deficit Government Spending and QE are theories developed in an environment of zero or low existing Government Debt.

Jul 09 11:59 PM