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Paul Krugman: How a Simple-Minded Analogy Has Wreaked Havoc

February 9, 2015 in Blogs

By Janet Allon, AlterNet

Misunderstanding debt has brought Europe's economy to its knees.

The world—especially Europe—has tragically misunderstood debt, Paul Krugman writes in his column Monday. And the results are catastrophic. As a result of too much austerity, and a scolding insistence that debtor nations continue to slash spending, Greece may have to exit the Euro, deflation is setting in, and Europe continues to stumble badly in the wake of the Great Recession.

Apart from Krugman, Janet Yellen gets this. She along with other responsible economists view the global economic troubles since 2008 mostly as due to “deleveraging.” This, Krugman explains, is “a simultaneous attempt by debtors almost everywhere to reduce their liabilities. Why is deleveraging a problem? Because my spending is your income, and your spending is my income, so if everyone slashes spending at the same time, incomes go down around the world.”

The problem has come about mostly because of a simple-minded analogy, one that sounds true and scores political points, but just isn't how it works. “As Ms. Yellen put it in 2009,” Krugman writes. 'Precautions that may be smart for individuals and firms — and indeed essential to return the economy to a normal state — nevertheless magnify the distress of the economy as a whole.'”

We are far from having returned the economy to a “normal state,” despite years of punishing austerity, and some of the lowest government spending rates in decades. Krugman cites a recent report from the McKinsey Global Institute titled “Debt and (Not Much) Deleveraging.” It found, “basically, that no nation has reduced its ratio of total debt to G.D.P. Household debt is down in some countries, especially in the United States. But it’s up in others, and even where there has been significant private deleveraging, government debt has risen by more than private debt has fallen.” 

Governments are not households or even small businesses that need to make sure not to overspend and go into crippling debt, and it is a misunderstanding to see them that way. Here's why, according to Krugman:

An indebted family owes money …read more


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