Paul Krugman Dismantles Crazy Conservative Economics

Europe has taken leave of its senses—or its economic leaders have. That, in a nutshell, is the case that Paul Krugman makes in his column Friday. America's economy may be making a stumbling, long overdue recovery, but the eurozone remains in deep doldrums, a crisis that Krugman compares to the 1930s.


A sort of mass hysteria has taken hold in Europe. No matter how much evidence piles up that slashing budgets and government spending is exactly the wrong way to go about creating confidence, economic leaders keep espousing austerity.

The problem does not lie with fundamental economic models, Krugman explains:

It’s true that few economists predicted the crisis. The clean little secret of economics since then, however, is that basic textbook models, reflecting an approach to recessions and recoveries that would have seemed familiar to students half a century ago, have performed very well. The trouble is that policy makers in Europe decided to reject those basic models in favor of alternative approaches that were innovative, exciting and completely wrong.

I’ve been revisiting economic policy debates since 2008, and what stands out from around 2010 onward is the huge divergence in thinking that emerged between the United States and Europe. In America, the White House and the Federal Reserve mainly stayed faithful to standard Keynesian economics. The Obama administration wasted a lot of time and effort pursuing a so-called Grand Bargain on the budget, but it continued to believe in the textbook proposition that deficit spending is actually a good thing in a depressed economy. Meanwhile, the Fed ignored ominous warnings that it was “debasing the dollar,” sticking with the view that its low-interest-rate policies wouldn’t cause inflation as long as unemployment remained high.

In Europe, by contrast, policy makers were ready and eager to throw textbook economics out the window in favor of new approaches. The European Commission, headquartered here in Brussels, eagerly seized upon supposed evidence for “expansionary austerity,” rejecting the conventional case for deficit spending in favor of the claim that slashing spending in a depressed economy actually creates jobs, because it boosts confidence. Meanwhile, the European Central Bank took inflation warnings to heart and raised interest rates in 2011 even though unemployment was still very high.

But while European policy makers may have imagined that they were showing a praiseworthy openness to new economic ideas, the economists they chose to listen to were those telling them what they wanted to hear. They sought justifications for the harsh policies they were determined, for political and ideological reasons, to impose on debtor nations; they lionized economists, like Harvard’s Alberto Alesina, Carmen Reinhart, and Kenneth Rogoff, who seemed to offer that justification. As it turned out, however, all that exciting new research was deeply flawed, one way or another.

Bottom line, had Europe just followed old-time economics, it would be a lot better off. But there is not sign of recognition of that fact. A recent Op-Ed article by Wolfgang Schäuble, the German finance minister, reiterates the bizarre theory that austerity leads to confidence, according to Krugman.
It's a headscratcher, when you think about it.
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