Correcting Paul Krugman’s historical fallacies

June 19, 3:23 AMEl Dorado County Conservative ExaminerCameron English

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AP Photo/ Hankuk Economic newspaper, HO

Tumultuous economic conditions have always been a breeding ground for bad history and half-baked, anti-capitalist ideas. The most recent example comes from economist and New York Times columnist Paul Krugman.

According to Krugman, the economy is on its way out of the recession and it’s all thanks to the wisdom of President Obama and the central planners at the Federal Reserve. Times are still tough, however, and these all-knowing public servants must be given enough leeway to tinker with the economy to bring it back to life. But, if policymakers give in to those kooky capitalists and let the market function freely, the economy will slip back into decline and all hope will be lost.

To support this hypothesis Krugman calls on history to attest that socialism really can revive a slumping economy if only given the opportunity. He writes, “The U.S. economy grew rapidly from 1933 to 1937, helped along by New Deal policies. America, however, remained well short of full employment. Yet policymakers stopped worrying about depression and started worrying about inflation. The Federal Reserve tightened monetary policy while FDR tried to balance the federal budget. Sure enough, the economy slumped again, and full recovery had to wait for World War II.”

It’s too bad for Krugman that this version of events is a complete fabrication, and anyone willing to open a history book can see why. Contrary to the assertion that the economy was “helped along by New Deal policies,” the central planning instituted during the 1930s resulted in disaster. Examples included artificially raising food prices by destroying existing food supplies, paying farmers to reduce their output, and raising or creating new taxes.
 

In fact, it was foolish New Deal policies, like the ones described here, which lead economists Richard Veder and Lowell Gallaway to conclude that “[t]he Great Depression was very significantly prolonged in both its duration and its magnitude by the impact of New Deal programs.”

Furthermore, arguing that the government didn’t do enough for long enough to revive the economy is to ignore the voluminous evidence which points to the opposite conclusion. The government actually did too much for too long and when they did begin to reign in the excessive intervention, it was too late.

This version of history begins with the Austrian Theory of the Business Cycle, a theory which suggests that governments cause economic downturns by inflating the money supply and artificially driving down the interest rate as a result.

In a market economy the interest rate is determined by the amount of savings that exist. If the individuals that make up that economy are willing to save money and put off their consumption, the interest rate will be lower since there is more saved money available to loan. But if individuals would rather consume, the interest rate will be much higher since there is less money available to loan.

But when central banks distort this important market signal by creating money from nothing, they sow the seeds for recessions and depressions. As Rothbard explains, “[b]usiness [is] seduced by the governmental tampering and artificial lowering of the rate of interest, and [acts] as if more savings [are] available to invest than [are] really there. As soon as the new bank money [filters] through the system and the consumers [reestablish] their old proportions, it [becomes] clear that there [are] not enough savings to buy all the producers' goods, and that business [has] misinvested the limited savings available.” The result is economic contraction as the “inevitable readjustments liquidate the unsound over-investments of the boom, with the reassertion of a greater proportionate emphasis on consumers' goods production.”

This is exactly what happened in the 1920s. The Federal Reserve increased the money supply substantially, which set into motion the predictable chain of events that ultimately lead to the Great Depression.

With this in mind, it’s hardly legitimate for Krugman and his intellectual allies to suggest that their preferred political arrangements will fix everything given enough time. History indicates that they have it completely backwards, and only by ignoring it can they propagate their fanciful story. Policymakers should learn from history, just not from Krugman’s version.