Debt and Partisan Economics Revisited

My last post, Partisan Economics, generated a lot of discussion and debate, although much of it was a back and forth between me and a textbook Keynsian.   
Before continuing, I want to address a point that Barry Ritholtz mentioned to me, stating that there are indeed a lot of deficit partisans out there who are acting with extreme hypocrisy.  This is indubitably true – and they should be held accountable as hypocrites.  However, this doesn’t mean that their newfound deficit concerns are unfounded, which is what I was trying to show in my post.
I already linked to Krugman and Reich on the subject, and Dean Baker weighed in yesterday as well.   On the other side, the Pragmatic Capitalist wrote a piece similar in tone to mine, and made some important clarifications about Keynsian Economics:
“The truth is – Keynesianism works – in the right environment.  It works well when debt is fairly low and organic economic growth is relatively strong, but exponential debt growth becomes an increasing concern every time you print your way out of an economic downturn.  The larger the downturn, the larger the response.  So on and so forth.  If you happen to enter a period of severe irrationality and spending the problems multiply.  If the recovery period is not used to pay down debts the problems become exponentially worse.  The tipping point comes when the debt burden hinders future economic growth and destroys your ability to spend your way out of any future recessions.  It effectively turns into one great pyramid scheme if it you let it get out of hand.”
 and then:
“In sum, the idea that you can turn on the debt spigot every time your economy gets into trouble is deeply flawed.  The major flaw in the Keynesian approach is that it ignores  exponential growth in debts.  As a government continually spends and prints to get themselves out of one recession the debt they incur slowly hinders their ability to overcome any impending economic woes.   Should they continue to attempt to print and spend their way out of each subsequent recession it becomes a negative feedback loop.  The debt hinders future economic growth, the potential for subsequent downturns actually increases and the ability to handle those downturns is severely reduced.  If fiscal imprudence continues in times of recovery you end up right where we are today.”
Dean Baker’s piece was the most surprising to me.  It echoes Krugman’s points, and generated some very intelligent replies in his comments section rebutting his claims.  One commenter rebuts Baker point by point, accurately, in my opinion:  it’s a must read here.  Here’s just a little taste, the first paragraph of eight:
“{Baker wrote:}“The country faces a serious crisis in the form of a manufactured crisis over the budget deficit”. {commenter responds:}The world is in the grips of the first truly global DEBT crisis of unprecedented proportions. Period. Public sector debt, corporate debt, personal debt: not even in the great wars of centuries past have we seen such extreme debt levels, when expressed as a percentage of GDP. It is one thing to say, “The ratio of (public) debt to GDP was over 110 percent after WWII”, suggesting that, therefore today’s numbers needn’t concern us. It is quite another to observe that, in fact, “total credit market debt as a % of GDP” at its WWII peak was less than 170%, whereas today it is more than double, at about 350%. In other words, WWII was financed with “public sector” debt; when the war ended, so did the expenditures, and the US enjoyed a financially solvent private sector with a suddenly expanded, hard working labour force with which to pay off the debt. Now we have comparable levels of public sector debt AND unprecedented levels of private sector debt; and anyone who ignores that inconvenient fact is a fool.”
Clusterstock republished a segment of Baker’s piece, and commenter Mike C clarified another nice, simple point:
Baker wrote: “The problem is that, as a society, we are not spending enough to keep the economy running at capacity.” 

Commenter Mike C responds:

“The problem is, for too many years we’ve had a seriously inflated idea of what our ‘capacity’ really is. Our economy running at ‘capacity’ is something more akin to 1985 levels than 2005 levels. The rest of that was a flood of easy credit and overleveraging…not actual capacity.”

Finally, Ron Paul weighs in.  Do with that one what you will…

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