Sunday, October 09, 2011

Volume 3 Issue 41: Two-Cent Economics

Scott Sumner Pwns Paul Krugman

The entire post is really long. Basically, Krugman has returned to his China-bashing ways with this article and personally, I don't see how a Nobel laureate can get it so wrong. As a result, Scott Sumner just bashes Krugman into the ground with his reply. Here are some excerpts:
But how do we know the yuan is undervalued? Its current value is not out of line with predictions of the Balassa-Samuelson Theorem, which predicts that countries with higher per capita GDPs will have higher real exchange rates. Krugman points to the huge Chinese trade surplus. But is their surplus actually all that large? After all, China is a very big country. As I pointed out earlier, the Germanic/Nordic current account surplus is vastly larger, despite the fact that the countries lying between Switzerland and Norway have a combined population only a tenth as large as China’s. The smaller East Asian countries also have vastly bigger surpluses on a per capita basis. So why focus on China?
What bothers me the most is Krugman’s assertion that China is “standing in the way” of an increase in US aggregate demand. This makes the Chinese seem like some sort of enemy of the US, even though the private actions of those thrifty Nordics are doing us far more harm, according to Krugman’s model. Even worse, it suggests that we are helpless victims, whereas even Krugman admits that the fundamental problem is that we don’t use monetary and fiscal policy to boost our own aggregate demand (AD.) So the “harm” being done is only harmful if our policymakers ignore textbook advice to keep AD at an adequate level. Yes, we are ignoring that textbook advice, but I’m having trouble seeing how that’s China’s fault. Again, I’m not arguing that there is any logical inconsistency there, but I can’t imagine that many of Krugman’s readers will connect the dots as I have. Most will assume that China really is “standing in the way,” not that we could offset any harm with the flip of a switch.
You can read the rest on your own. Personally, I think it is this finger-pointing that has got America into where it is right now. America is like a big bully in high school, or a jock, if you will. They have pretty much had things the way they wanted their whole lives and now, something doesn't go their way, they just can't get their heads around it. America needs to do a lot of soul-searching and accept a little bit of bitter medicine in the form of humility and understand that they themselves are the problem.

As Scott Sumner aptly puts it at the end of his piece:
The worst mistake the world could make right now is to descend into nationalistic posturing. We can all see what’s going on in Europe, and we all know how nationalism can end up hurting everyone. The last thing we should be doing right now is pointing fingers at foreigners.

We have the ability to solve our own AD problem; now we need to get on with doing it. If the Senate wants to do something constructive, give the Fed a mandate consistent with what the Senate wants the Fed to accomplish. If the Senate wants more AD, don’t try to take it out of the pockets of Chinese workers. Let’s do it the way economics textbooks say it should be done, with Federal Reserve targeting of prices or NGDP.
Don’t make policy based on zero sum thinking. The world needs growth, not trade wars. 

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