The Kroog Versus The Fire Sale

Paul Krugman notes the supply siders are waving the white flag and are shifting into "semi-permanent capacity reduction mode"...the notion that with many of the 8 million jobs lost never coming back, it's time to sell off the excess capacity and get what you can for it.  Growth?  What growth?  The depression is coming.

I’ve been surprised by a lot of things since the financial crisis broke, few of them good. One of the truly amazing things, however, is the return of full, 1930s-type liquidationism — the idea that a slump serves a useful purpose, and that stimulating the economy, even through monetary policy, is a mistake. And so we have Raghuram Rajan in today’s FT arguing that with 9.5 percent unemployment, long-term unemployment at record levels, and falling inflation, we need to … raise interest rates:

This crisis followed a period, from 2002-2004, when monetary policy had done too much heavy lifting. The US had far too much productive capacity devoted to houses and cars, because consumers could obtain financing for them easily. With households now struggling with this remaining debt, should we expect them to spend beyond their means again, or ask them to do so?

Moreover, if consumers are now going to want fewer houses and cars, a significant number of jobs will disappear permanently. Workers who know how to build houses, or to sell or finance them, will have to learn new skills. This means resources have to be reallocated into other sectors to ensure a robust recovery, not simply a resumption of the old binge. But this will not necessarily be facilitated by ultra-low interest rates.

Well, I have to agree with the Kroog here.  Rajan's theory is once again supply creates demand...only that we have over-supply so by moving people to other industries and investing in them demand for those other industries will be created by...Magical Demand...Gnomes...or something, I guess.  I don't get it, Rajan admits right there that the problem is lack of demand, and his solution is to shuffle supply around.

We call that "rearranging the deck chairs on the Titanic."  Quite literally, that's what his plan is.  I guess what he doesn't get is the fact that lack of demand is a symptom of an even greater problem, and that's the fact that wages have stagnated for so long and wealth has been transferred out of the vanishing middle class for so long that there's nobody left to buy crap.

Krugman notes too that we've seen this all before.

If high unemployment were largely about shifting workers out of an overblown construction sector, wouldn’t you expect job losses to be concentrated in that sector? Wouldn’t you expect employment elsewhere to be, if anything, rising? In fact, however, the vast majority of job losses have occurred in parts of the economy with little direct connection to the housing bubble. Yes, as a percentage job losses have been much larger in construction; but nothing in Rajan’s argument explains why we shouldn’t be using policy in an attempt to prevent vast job losses in parts of the economy that aren’t overblown.

I’d add that even if you think structural unemployment has gone up, it clearly hasn’t risen enough to stop a slide toward deflation — and if it has risen, the slump is arguably a cause, not an effect, of that rise.

Ding ding ding!  Kroog in one, ladies and gents. And yet all the plans I'm seeing are "Hey, let's transfer more wealth away from the middle class and destabilize our consumer based economy."  The point here isn't to save the economy, the point here is to raid the treasury to build fat, load-bearing piles of cash that the guys at the top can use to ride out the floods high and dry while the rest of us drown.

So many people seem to be employed these days in convincing us to go along with this plan, too.

Of course, there's the concept of a complete over-correction on the demand thing and accomplishing the same thing as the supply shuffling only in a much more messy style...