Krugman on Learning from Greece's Debt Crisis

A friend sent me Krugman's op-ed last week with a note that said "it's annoying when he's right." Instead of writing back, I figured I would post my response here.

Krugman is right about some things with respect to Greece, and even with respect to policy prescriptions for fighting unemployment in the US today, but he goes off the rails in a couple of places. The central point of the article -- that putting in place austerity measures (i.e. cutting the government budget and raising taxes) is counterproductive -- is certainly correct. And his point that Greece is in a completely different position vis a vis the US because it does not own the printing press for the currency in which its debt is denominated is also correct.

But Krugman still uses the terminology of a gold standard or a fixed exchange rate system, which has no application to the US system of a fiat currency with a fully floating exchange rate.

Despite the fact that Krugman's penultimate sentence is a tautology, he fails to understand that the US debt is always manageable from a credit risk perspective because the public debt is nothing more than an interest-bearing form of money. The deficit is self-financing because, at the close of business each trading day, every dollar of deficit spending (as well as every other dollar that was created previously) either finds a home in an interest-bearing government security or earns 0% under somebody's mattress.

The only problem with having too much debt/money is too much aggregate demand, which causes inflation and the mal-investment and perverse behavior associated with it. But the acid test as to whether we have too much debt/money is whether we have full capacity utilization and inflation, which we clearly do not.

Warren Mosler uses full employment (net of the structural rate of unemployment) as his metric for whether the private sector has enough money, although I am not entirely convinced that's useful because the government is quickly raising the rate of structural unemployment through stupid policies (e.g expanding entitlement programs and raising the minimum wage).

Krugman is also not correct when he says that there are no good solutions to the Greek crisis. Mosler's solution of having the European Central Bank (ECB) distribute 1T Euros annually, on a per capita basis to each member country in the European Monetary Union (EMU) is a good one. Aggregate demand would be restrained by the fact that the member countries would still be restricted from spending the money by the terms of the Maastricht Treaty. The penalty for any country breaking the spending restrictions would be for the ECB to withhold the annual payment to that country the next year (a much easier penalty to enforce than actually fining a country 1/2% of GDP -- talk about getting blood from a stone!).

I would add to this solution the idea that the EMU should put in place policies which promote the holding of Greek debt by Greeks and not by European banks. That way, in ten years' time, when Greece gets into trouble again, the Greeks will be left holding the bag themselves, and they can be kicked out of the EMU without too much disruption.

So Krugman almost gets it with respect to the US, but not quite. And he completely fails to realize that the solution to Europe's problems is for the ECB to give each EMU country a kitty of pre-printed money to call on for debt repayment as needed. The EMU countries will not own a Euro printing press individually, but they will have the next best thing.