“The third depression” – critique

Krugman (2010) article presents a main issue of macroeconomic debate in the modern time. As economies have experienced many business cycles over a large period of time the main issue of debate has been whether government’s direct intervention to promote desired short-term outcomes on the economy is beneficial or detrimental in the long-run. Should the government adopt a laissez faire approach in times of depression or should it put measures to spur growth? The classical view point continues to argue for a laissez-faire approach where the government leaves the economy to recover on its own – avoiding massive expenditure to spur growth in times of depression since such would be based on huge debts incurrence (Colander, 2008). Krugman (2010) article seems to argue on the contrary, adopting a Keynesian approach “…..but because Republicans and conservative Democrats in Congress won’t authorize additional aid to state governments, that austerity is coming anyway, in the form of budget cuts….” (P. 1). Such indicates that the author is in favour of increased spending by the government as a reaction to the current crisis.

Such increased spending in times of crises could create the necessary demand to put the economy on a recovery trajectory. This would be the case when the economy is at levels below the potential income level – i.e. when the economy is in a recessionary gap (Colander, 2008). Increases in government expenditures would alleviate unemployment levels and increase output if entities that benefit from the government contracts hire some more labour (Colander, 2008). Similarly increases in hired people would boost the incomes of households thus increasing their marginal propensity to spend if prices of commodities remained unaltered (Colander, 2008). Such an effect would result in a multiplier effect where additional demand – due to increased incomes – would spur additional output to meet the increased demand thus spurring the economic recovery process (Colander, 2008). Government expenditure, as contended by Krugman, when directed to the rightful channels would thus provide a step stone for recovery efforts. However, not all government expenditure is beneficial, a point that the article does not seem to clarify. Government expenditure directed towards welfare – e.g. massive organization bailouts witnessed in the U.S – may not have an economic recovery effect. Such expenditure would for instance not lead to higher employment thus the multiplier effect may not accrue.

The second concern of Krugman (2010) article relates to the correctness of policy initiatives aimed at curtailing public expenditure leading to inflation. On this second aspect the article contends on the wrong timing of the contractionary policies that “…there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors” (p. 1). Such contention also appears well grounded since economic recovery could be hard to achieve by restricting household expenditure in times of crisis. Such austerity measures are the preserve for periods of deflationary trends – where taxation and monetary policy initiatives can help reduce public expenditures to desirable levels. The policy alternative in relation to the Greece issue thus seems to be ill-timed coming at a time when a more expansionary policy would yield better results.

Both of these cases seem to confirm that governments should play a critical role in addressing economic outcomes. The Greece crisis for instance evidences the lack of government control thus resulting into a much deeper crisis from which recovery seems – by markets own time frame – far fetched. Similarly the advent of the current financial crisis is partly attributed to misapplication of policy (over application of low fund rates). The main contention that remains in regard of government involvement is thus not its involvement, but rather whether it can rightfully get involved to better the outcomes. go to the conclusion here.

 

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