Krugman on Canada's Austerity By David Henderson

Two days ago, I complimented Paul Krugman for a short blog post he did.

Today he came about as close as he ever does to returning the compliment, which is to say, not close at all. But at least he discussed one of my favorite topics, one I have written about and that he criticized indirectly.

Krugman wrote:

For comparison, look at everyone’s favorite example of successful austerity, Canada in the 1990s. Canada came in with gross debt of roughly 100 percent of GDP, roughly comparable to Greece on the eve of the financial crisis. It then proceeded to do a pretty big fiscal adjustment — 6 percent of GDP according to the IMF’s measure of the structural balance, which is about a third of what Greece has done but comparable to other European debtors. But unemployment fell steadily. What was Canada’s secret? The answer was, easy money and a large currency depreciation. These offset the drag from austerity, allowing growth to continue.

In other words, he talked about one of my favorite examples of successful austerity, the case of Canada, which I studied here. It’s not my absolute favorite. My absolute favorite is one I documented here, in which the U.S. government cut spending, not by a measly 6 percent of GDP, but by about 35 percent of GDP. The result, as President Truman pointed out at the time, contrary to the predictions of Keynesians Paul Samuelson and Gunnar Myrdal, was a postwar economic boom.

Notice, by the way, true to form, Krugman never mentions that almost all of that 6 percent swing took the form of cuts in government spending, not tax increases. Also, notice that in the graph he links to, most of the fall in the Canadian dollar had occurred about the time the big budget cuts began.

Krugman’s statement I’m quoting, as Danny Devito’s character says in the movie “Other People’s Money,” should be followed by “Amen, and Amen, and Amen.” Because, as DeVito said, what you just heard was a prayer. Or, more exactly, a statement of faith. Austerity had to create a drag. Because that’s what his model says. So, of course, the factors that must have been strong enough to offset the drag were monetary policy (which, notice, he doesn’t give a link about) and a fall in the value of Canada’s dollar. And not just offset the drag, but trigger a boom. (By the way, I do think monetary policy may well have been important, but, as I’ve noted, Canadian economist Stephen Gordon’s way of measuring it–a 500-basis point drop in interest rates–is absurd. David Beckworth measures it the same way as Gordon.)

Krugman never criticized my study directly. Instead, he linked to the criticism by the aforementioned Stephen Gordon, a criticism that I have answered here.