Krugman Needs Reagan to Make His Growth Argument

Science can advance more quickly when there is the ability to construct controlled experiments within which variables and their effects can be isolated. Observational sciences like astronomy or archeology cannot construct direct experiments, but try to create explanations consistent with the more traditional sciences like physics and chemistry and ongoing observation. Economics falls in this latter category without the advantage of some reliance on other sciences. Given the unprecedented nature of today’s economic circumstances, prudence should restrain the certainty of any prediction.

Nonetheless, in terms of our future prospects, the importance of economic growth is conceded by all. If the extremely large spending increases of the Obama plan result in very significant economic growth say 4-5% per year range, growth will generate sufficient government revenue that service on the debt will not strain the economy. The question reduces to  what level of growth will result after the implementation of the Obama stimulus package.

Nobel-prize laureate Paul Krugman argues that historical evidence suggest periods of strong economic growth quickly follow high unemployment to support Obama assumptions about growth. There is some plausibility to this view. After unemployment peaks, putting labor back to work should increase output or gross national product. Indeed, Krugman suggests that when Harvard economist Greg Mankiw (who specializes in macro economics as opposed to Krugman’s international trade specialty) arguments otherwise are “evil” wonkishness. Mankiw responded that if Krugman is so sure that he is willing to risk the economy on his prediction, perhaps he might be willing to wagee a small fraction of his Nobel prize. Frankly, aw we shall see the data are so murky, that I would not wager much on either prediction.

Krugmam cites data to support his assumption of growth from Brad Delong.

The above graph shows the  unemployment rate on the horizontal axis and future economic growth 2 years later on the vertical axis. The association is not particularly strong, The points on the far right of the regression line seem to drive even the weak association in the graph. After Mankiw’s response to Krugman,  Delong went back and looked at the data. He found that those points on the end of the regression curve, as guessed by Mankiw, were associated with the Reagan recovery in the early 1980’s — a recovery dominated by large reductions in the highest marginal tax rates. Refer to the graph from Delong below.

The pink points are the ones associated with the Reagan recovery. Thus, Krugman is relying on the Reagan recovery to support his confident assertion strong growth inevitably follows high unemployment rates. Although the deficit rose during the Reagan years, at least at first, it was associated with increased defense spending coupled with reducing marginal income tax rates. Obama stimulus relies on high levels of spending and increased marginal tax rates. The past evidence does not allow us to predict with even modest assurance that high rates of growth are to be expected. For Krugman to make this argument confidently without caveat suggests at least at best some ignorance of the past.

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