Paul Krugman commented early this morning on the Wall Street Journal oped by John Cogan and me. Our oped is based on our research paper with Volker Wieland and Maik Wolters which shows that there are beneficial effects on the economy—in the long run and the short run—of a ten-year program to reduce the budget deficit, and eventually balance it, as proposed by the House Budget Committee.
Krugman’s claims about this research are wrong.
He complains that we get these results “because confidence!” But we never mention confidence in the oped or in the research paper with the simulation results. Our model includes concepts like the permanent income hypothesis, incentive effects, and of course people taking expectations of the future into account when they make decisions
Krugman claims that we are unfamiliar with research by “Mike Woodford, who they appear never to have read.” In fact, the research paper by Mike Woodford, who was the co-editor with me of the first Handbook of Macroeconomics, refers to our modeling research and we in turn have referred to his paper in subsequent research (pp. 85-114). Moreover, the research of ours that Woodford refers to was validated by many researchers at central banks and international financial institutions.
Krugman disagrees with our statement that “resources to finance government expenditures aren’t free—they withdraw resources from the private economy” saying this isn’t so in a depressed economy. But the whole point of our simulations is to show how a gradual and credible fiscal consolidation will help get the economy out of its depressed state and into an economic situation where people recognize that lower growth of government spending eventually means lower taxes and more take home income.
The paper by Woodford that Krugman refers to uses expectations, as we do, but that paper is about a completely different policy question. As Woodford says he considers “only the consequences of temporary variations in the level of government purchases.” In contrast, in our Wall Street Journal article and our research on fiscal consolidation we consider the effect of permanent changes in government spending which are phased in over time to bring the budget deficit down.
Not mentioning this crucial difference, Krugman goes on to claim that we get our results because “we have slipped in some assumption” and then guesses what that might be. In our oped, we summarize the assumptions and the reasons for our result that the plan is good for the economy, and a higher interest rate is not one of them.