Liberal Economist Takes On Krugman: Federal Reserve Averted Depression NOT Obama

March 11th, 2013 9:29 AM

While you were watching Rand Paul's historic filibuster and the debate surrounding budget sequestration, an economic theory battle was waging between two of the nation's foremost liberal economists Paul Krugman and Jeffrey Sachs.

In his most recent salvo published at the Huffington Post Saturday, Sachs spoke heresy to Obama-lovers across the fruited plain including Krugman claiming that following the 2008 financial crisis, "It was the Fed, not the fiscal stimulus, which prevented a fall into depression."

"Professor Krugman and Crude Keynesianism" is a rather lengthy piece from Sachs that includes a lot of economic facts and figures that might bore most readers, but is well worth your time.

In it, he addressed where Keynesians such as Krugman and Obama went wrong in 2009, and why their theories today aren't working.

The long and the short of it is that the Administration backed by economists such as Krugman believe deficits and debt don't matter, and that any government spending regardless of how random and untargeted will have a positive economic impact.

Sachs disagrees:

The original stimulus legislation was overwhelmingly of the form of temporary tax cuts and temporary transfer payments, the kind of deficit spending especially likely to have little effect on aggregate demand. Only $88 billion of the $787 billion stimulus-package was in direct purchases of goods and services by the federal government. The rest was temporary transfers and tax cuts.

(This was not an accident. A critical and predictable weakness of the 2009 stimulus is that House Democrats and the White House negotiated it in just a few weeks. In the unnecessary haste, there was no serious consideration given to long-term needs in infrastructure, for example. With presidential leadership we could -- and should -- have forged a decade-long strategy. Now we have no such strategy in place or likely to come into place.).

Maybe we should also blame Rahm "Don't Ever Let a Good Crisis Go To Waste" Emanuel for the "unnecessary haste" associated with Obama's stimulus plan.

Maybe if we had taken more than a few weeks to put together a package that everyone on Capitol Hill actually read our $787 billion would have been better spent.

The Keynesian theory is that the stimulus would raise output and employment while the economy naturally returned fairly quickly to full employment and rapid growth from the cyclical downturn. This long-term recovery did not occur as projected. Growth has not resumed on a normal basis. The Keynesian CBO model failed very badly to track the U.S. economy. [...]

The Administration should indeed have taken several months in 2009 to design and advocate for long-term investment programs for renewable energy, fast intercity rail, large-scale highway upgrading, large-scale skill and job training, and so forth, rather than rushing to pass a stimulus package of hundreds of billions of dollars of shortsighted and largely ineffective temporary tax cuts and transfer programs. The budget should have paid for such new long-term investments by allowing the temporary Bush-era tax cuts to expire on schedule in 2010 (or by negotiating equivalent revenues of 2-3 percent of GDP per year as the price for maintaining the Bush-era tax cuts).

One of the Obama arguments at the time was that the rush in the stimulus program was needed to avoid a Great Depression. This was and is highly doubtful (though, yes, it is widely accepted). The US economic emergency in late 2008 and early 2009 wasn't really an aggregate demand crisis but a financial crisis. The chaotic failure of Lehman Brothers had led to an intense panic and credit squeeze. The Fed therefore needed to flood the markets with liquidity, which it rightly did, in order to unwind the panic. The Fed's action was the real difference with 1933 (when the Fed allowed the banks to fail). It was the Fed, not the fiscal stimulus, which prevented a fall into depression.

So Ben Bernanke deserves the credit for averting a depression NOT Obama.

This will certainly come as a shock to the current White House resident's devotees in the media.

Yet Sachs is right. Monetary policy typically has a far greater impact on the economy than fiscal policy.

Unfortunately, the economically-challenged press never understands that. They see presidents as having much more power than is ever really the case.

It makes for far better so-called "news" stories.