James Pethokoukis

Paul Krugman makes his case for the New Normal:

1) Earlier recessions were preceded by sharp rises in interest rates, as the Fed tried to choke off inflation. This produced a housing slump, with a lot of pent-up demand; when the Fed decided that we had suffered enough, it relented, and both housing and the economy sprang back.

2) But later recessions took place in a low-inflation environment, in which booms died natural deaths from overextended credit and overbuilding. Getting the economy growing fast enough to bring unemployment down after these recessions was therefore much harder, since the usual channel of monetary policy — housing — lacked any pent-up demand.

3) So what about our current situation? It’s just like the two previous “postmodern” recessions, only more so, since the bubble before the slump was in housing itself. This suggests a long period of jobless growth; so does the international evidence on the aftermath of financial crises.

That said, there’s been a lot of optimism out there lately, reflected in the steepening yield curve. I’d like to think that’s right. But Ed McKelvey at Goldman (no link) has a new report titled “Recovery more Ho-Hum than Ho-ho-ho”, in which he acknowledges that growth will be good this quarter, but presents evidence that it’s all a temporary inventory bounce.

What a weird column from Paul Krugman. He says Americans shouldn’t worry about the ten-year budget forecasts ($9tr debt,  70 percent of GDP) because a) plenty of other nations have had far higher ratios, b) other countries continue to lend to the US, and c) it’s the longer-term liabilities that are the problem.

But at what point do interest rates rise — especially since huge current deficits give markets scant confidence that America is serious about fiscal soundness? And the current deficits make the fixes to entitlements harder to do. Clearly Krugman wants a Stimulus 2.0 program. He should take a look at my plan to create fiscal space in the present by dealing with entitlements now. And heaven help us if we get another financial crisis within the next generation …

Paul Krugman worries that phony inflation fears will lure policymakers into withdrawing fiscal and monetary stimulus too soon. In the process, he takes a shot at Reaganomics:

And Republicans, providing a bit of comic relief, are saying that the stimulus has failed, because the enabling legislation was passed four months ago — wow, four whole months! — yet unemployment is still rising. This suggests an interesting comparison with the economic record of Ronald Reagan, whose 1981 tax cut was followed by no less than 16 months of rising unemployment.

Me: But as pointed out in the wonderful book “The End of Prosperity” (authored by my pals Art Laffer and Stephen Moore),  the way the Reagan tax cuts were structured meant that familes only got a meager 1.25 percent tax cut in 1981 and 10 percent in 1982. When the Reagan cuts really kicked in 1983, so did the economy.