Consumers Don't Cause Recessions

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There’s one saving grace about Paul Krugman’s column at the New York Times: when an Austrian economist wants to explain how mainstream economics leads to ruin, he can always trust Krugman to set up the target in a clear, concise manner. This saves us a lot of work, because we don’t have to first build up the position before knocking it down.

Even the casual reader of the financial press knows that it is dominated by Keynesian "demand-side" thinking. For example, during the debate over the stimulus checks earlier in the year, the main objection was that taxpayers might use some of their rebate to pay down credit card bills, rather than blowing the whole thing at the mall. But the reader will never see a careful, step-by-step exposition of the worldview that generates such crazy notions.

Enter Paul Krugman. In a recent piece, "When Consumers Capitulate," the newest Nobel laureate spells out the method behind the madness. Let’s take the opportunity then to show just why this focus on consumer spending is not only mistaken but downright dangerous.

"The Paradox of Thrift"

Krugman first tells us the (allegedly) bad news: "The long-feared capitulation of American consumers has arrived…[R]eal consumer spending fell at an annual rate of 3.1 percent in the third quarter; real spending on durable goods (stuff like cars and TVs) fell at an annual rate of 14 percent."

Now let’s stop for a moment. Many left-leaning writers — including Krugman — have been warning for years that the US trade deficit was too high, and that the national savings rate was too low. So one would think that a drop in consumer spending would be a good thing. Ah, not so fast: Krugman tells us that "the timing of the new sobriety is deeply unfortunate….For consumers are cutting back just as the U.S. economy has fallen into a liquidity trap."

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Bob Murphy [send him mail] runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism.

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