Felix Salmon has published an interesting summary of a debate in Canada last night featuring Paul Krugman and Larry Summers (more here, here, here and here). The question presented was whether “North America faces a Japan-style era of high unemployment and slow growth.” Krugman thinks so while Summers does not. As described by Salmon, the heart of the dispute was as follows.
They both quoted Keynes as diagnosing “magneto trouble” — the engine of the economy is broken, and it needs to be fixed. Summers has faith that, in Churchill’s phrase, “Americans can always be counted on to do the right thing, after they have exhausted all other possibilities” — the right thing, here, being to fix the magneto with expansionary fiscal and monetary policy. Krugman, by contrast, sees political gridlock as far as the eye can see, and says that it doesn’t matter how innovative or philanthropic or demographically attractive the U.S. is — if you don’t fix the magneto, the car won’t start, and America’s magneto ain’t gonna get fixed any time soon.
Not surprisingly, I think they’re both wrong and think that David Rosenberg (who was aligned with Krugman for the purposes of the debate) is much closer to the truth than his partner is. Krugman remains convinced that a the problem with the stimulus implemented so far is that it wasn’t nearly extensive enough. In his view, much greater borrowing and spending would fix what ails the economy (to be fair, I agree with Krugman that political gridlock will make any solution requiring a political contribution likely to fail). As he wrote in The Return of Depression Economics and the Crisis of 2008, “A recession is normally a matter of the public as a whole trying to accumulate cash (or, what is the same thing, trying to save more than it invests) and can normally be cured simply by issuing more coupons.”
The question, then, is if this time is “normal” or if the problem is so severe that a few “coupons” won’t do the trick. Rosenberg is in the “so severe” camp. He thinks that we’re at the beginning of a massive and worldwide deleveraging that will be necessary before we see substantial economic improvement. In his view (and that of people like Ken Rogoff, Steve Landsburg, McKinsey and me), you can’t fix an over-indebted economy by piling even more debt onto it.
We simply cannot expect people to start spending more when (a) they’re trying to get themselves out of hock; (b) they continue to perceive themselves as financially at risk; (c) the house they have (which may be underwater) cannot be expected to appreciate nearly enough to bail them out; and (d) they keep hearing and seeing why they need to be saving more for the future (especially for retirement) rather than spending.