The answer is ‘inflation’. What was the question?

Martin Wolf recently committed the Financial Times to a $71.88 lunch-time interview with Paul Krugman. Whatever the quality of the meal, the interview was poor value. Three questions were covered: what the Federal Reserve got wrong; what Japan got right; and how the eurozone might be saved. In each of the three areas, inflation provides the key.
Krugman – ‘most hated and most admired columnist in the US’ – writes two columns a week, posts regularly on his blog and writes popular books in addition to his teaching at Princeton. Within academia, Krugman pins his hopes ‘on younger economists doing empirical work’ which he sees as the ‘salvation of economics’.’

In taking to journalism with the New York Times in 1999, Krugman quickly realised ‘that the whole world was mad, save me, or vice-versa’; but over twenty years he moulded himself into ‘the pundit conservatives detest and liberals cheer’.

So, what has Krugman to say about the widespread acceptance of ‘the need to slash entitlement spending – rather than to raise taxes – when the federal tax ratio is exceptionally low and there have been extraordinary shifts in the distribution of income?’ In part he explains this by ‘lavishly financed’ right wing think-tanks. Here, Barack Obama must play a long game, if he is not to lose campaign funding. Although David is pitched against Goliath, the cause of true values has ‘an organised progressive infrastructure … tiny and ill-funded … [but] … smarter than the other side.’

Krugman affords the US Federal Reserve no credit for having avoided deflation. Inflation/deflation per se is irrelevant to ‘a persistently depressed economy’. Although the economy was stabilised by the aggressive and forceful response of quantitative easing, which was ‘the right thing to do’, nothing followed when monetary policy was shown to be impotent. The critical omission was not to have addressed expectations by signalling ‘that you’re going to keep your foot on the gas pedal’. It was imperative for the Fed to give some indication that its inflation target would be no impediment to allowing ‘3.7 per cent annual inflation over five years’.

Krugman discounts entirely the consequences for policy credibility: ‘the evidence that anti-inflationary credibility is actually an important thing in the real world is basically nil.’ Thereby, Krugman takes individuals for the self-same fools as those deemed to suffer money illusion in the 1960s, when Keynesians insisted upon the existence of a permanent inflation-unemployment trade-off.

With regard to the eurozone, Krugman gives thumbs down to Greece, but the rest might be saved by allowing inflation to rip; that is, if Germany were to permit ‘open-ended financing and macroeconomic expansion’. A lesson is available. From the Japanese crisis of the 1990s, the manner in which the aftermath was handled presents Japan ‘as almost a role model’. Through most of the ‘lost decade’, Japan had a growing income per capita.

(Note to Krugman: with bank bailouts and stimulus programmes, Japan’s sovereign debt soared and continues to do so. As a proportion of GNP, by the end of this year its level will be above that of Greece by fifty percent. The difference is that Japanese saving finances ninety-three percent of government borrowing. Had the Greeks been so minded…)

Krugman believes the eurozone to have been ‘basically fated, from the day the Maastricht Treaty was signed’. While he is not on record with any contemporaneous warning, an economist who rests all upon empirical evidence can only wait for the evidence to show. Others, including Milton Friedman, understood from the beginning that ‘on purely theoretical grounds, it’s hard to believe that it’s going to be a stable system for a long time.’ Having finally caught up, Krugman advises that a full fiscal union would be the best outcome, but the current setup makes that unworkable. So, once again, inflation is the pragmatic way forward.

One final question from Martin Wolf, on how Krugman finds the time: ‘I probably work 70 hours a week but not 100 hours a week. But I am damned fast. I write faster than just about anybody in journalism, it turns out, which is interesting.’ Perhaps so, but no surprise: who would doubt that superficial commentary is ‘alarmingly easy’ to write?