A little bit pregnant
By Scott Sumner
Paul Krugman has a new post of mercantilism:
Neil Irwin has a good think piece on Trumpism and the trade deficit; but as Dean Baker rightly suggests, it arguably suffers a bit from being a discussion of the effects of trade deficits in normal times. And these times aren’t normal.
In normal times, the counterpart of a trade deficit is capital inflows, which reduce interest rates, and there’s no reason to believe that trade deficits reduce employment on net, even if they do redistribute it. But we are still living in a world awash with excess savings and inadequate demand, where interest rates can’t fall (or at any rate not much) because they’re already near zero. That is, we’re in a liquidity trap.
Actually we are not in a liquidity trap, and it’s not even debatable. Just as a woman cannot be a little bit pregnant, you are either in a liquidity trap or you are not. In the case of the US in 2016, we are not in a liquidity trap. Hence liquidity trap theories do not apply. Krugman’s post is completely wrong, because it’s entirely built on the incorrect assumption that we are in a liquidity trap.
When Krugman uses the liquidity trap excuse to justify an otherwise counterproductive policy (such as mercantilism, fiscal stimulus, or artificially higher wages) the term has a very specific meaning. It does not mean “interest rates close to zero.” It means interest rates higher than the central bank would prefer. The Fed raised rates in December, and will probably raise them again in June. Interest rates are relatively low, but they are obviously not
lowerhigher than the Fed wishes. So Krugman is simply wrong.
To the casual reader this Krugman post may seem like more of the same, but it is actually another step away from the neoliberal analysis that he produced in the 1990s. The first step was when Krugman claimed that fiscal stimulus and mercantilism are only justified when interest rates are at zero. I disagree with that view, but it’s a defensible argument. Now he claims that these policies merely require that interest rates be relatively low. That’s not even a defensible argument. If rates are low but non-zero, then the central bank has NGDP right where they want it. Right now it’s in the central bank’s power to raise NGDP growth as high as they like. If we fall back to the zero bound, it would be 100% the fault of the central bank, no one else. Unfortunately, it seems likely that we will fall back to the zero bound in the very next recession. We don’t need fiscal stimulus or mercantilism; we need to fix the monetary regime.
There are many other problems with the analysis. Krugman links to a Dean Baker post that suggests the current “secular stagnation” is mainly caused by the trade deficit. But secular stagnation is occurring all over the developed world, including those countries with trade surpluses. Indeed the US is doing better than most other developed countries. The one country that avoided a global recession in 2008-09 was Australia, which has an even bigger deficit, as a share of GDP. Japan has a big surplus. Whatever you think of trade deficits, there is little evidence that trade deficits lead to slower economic growth.
PS. Krugman’s post cannot be saved by pointing to the global economy, which does have many countries at the zero bound. The global economy has no overall current account deficit.
PPS. In this post I’ve assumed that zero interest is the lower bound. If the actual lower bound is a minus 0.75% interest rate, then Krugman’s argument is even weaker.
PPPS. The current account deficit in America is almost identical to 30 years ago, as a share of GDP. Trust me, it has nothing to do with “secular stagnation.”
HT: Benn Steil