A Keynesian Debate
The debate over Keynesian orthodoxy is raging. Most recently, in a NYT op-ed, Paul Krugman suggested we are in the beginning stages of The Third Depression.
We do not fully subscribe to Krugman’s analysis for a number of reasons. First and foremost, the Keynes prescription to spend to spur aggregate demand assumes borrowing capacity (or tolerance by lenders). The US economy is more diversified than Greece’s economy and should therefore be more resilient to borrowing; however we are not sure where the tolerance for increased borrowing capacity is capped in the US. In addition, we are not certain that aggregate demand needs to be spurred through borrowing (debt-fueled demand is not sustainable).
Krugman ignores global imbalances which, if righted, could lead to sustained economic growth. Principally, the unusually high savings rates and abnormally low consumption rates in places like China. China is presently adopting measures to realign their currency and spur local demand.
When to reduce spending and by how much is a very complicated decision. Economic activity may be at a much lower level, but if it’s moving in the right direction, we believe reductions in spending can be tolerated without driving the economy into a depression.