What Is the ‘Deficit Hawks’ Plan to Create Jobs and Consumer Demand?

BY Chris Amico  July 8, 2010 at 6:09 PM EST

Question: Paul Krugman knows something about macroeconomic theory, and his NY Times blog has lately been despairing. The “deficit hawks” around the world seem to be winning the day over Keynesian policy with their calls for LESS public spending, despite very high unemployment.

Krugman says they have forgotten proven macroeconomic truths. He argues that when you’ve already cut interest rates to near-zero and the economy remains in terrible shape, the government has to step in and spend borrowed money to generate demand and jobs. He says if gov’t doesn’t borrow and spend, then gov’t will actually lose revenue, and run bigger deficits, due to continued economic weakness, high safety net spending, and lost tax revenues.

Elsewhere I heard Mr. Taleb call Krugman a “danger to society.” Taleb says that since there’s only been one Depression, Keynesian theory is simply theory, not backed by sufficient evidence to justify the risks of huge public borrowing. I have accepted Krugman’s view as correct, but I’m really surprised at the emerging consensus to the contrary — even from savvy people like Taleb and Roubini. If Krugman and Keynes really are misguided, then are the deficit hawks simply telling us to accept 9.5 percent unemployment? What is their policy for reviving consumer demand and jobs?

Paul Solman: I think you’ve hit on the problem here, as many see it: Economically, we may be between a rock and a hard place. Krugman et al. think we have no choice but try further stimulus. The human cost is simply too great — in terms of current unemployment — and there’s even the possibility of a double dip recession if we don’t spend enough that would put us, and the global economy, right back in the soup. (See our take on the “shape of recovery,” complete with Simon Johnson and alphabet soup.)

The Keynes/Krugman strategy is actually a point of vigorous debate between Nassim Taleb and Nouriel Roubini, which they debate as a Web Extra on our website. Taleb’s position, in a nutshell: Whenever government gets involved, it makes things worse — like guaranteeing banks that are too big to fail, and thus encouraging them to take crazy risks.

But the other side of that coin is federal deposit insurance. Yes, it encourages banks to take risks with depositor money. But it also prevents bank runs and economy-wide panics that can destroy wealth and lives. See Robert Skidelsky explaining this — and libertarian Russell Roberts disagreeing — in a piece that ran in December.