I won’t get into the particulars, but in a blog post yesterday, Paul Krugman argued that the Baltic states, and Latvia in particular, are not examples of successful “austerity” policies, despite a rising GDP and falling unemployment. He comments (bold emphasis mine):
People praising the Baltics tend to brush off the observation of still-high unemployment and output still well below pre-crisis peaks by claiming that the high output and employment of 2006-7 were a bubble and we shouldn’t expect them to come back. I don’t think they realize just how problematic an argument this is.
First of all, the idea that real GDP and employment can be hugely inflated above sustainable levels by a bubble is questionable. We know that economies can operate far below capacity; operating far above capacity is a tougher proposition to defend.
…The claim is that Latvia shows that austerity works as a response to a deeply depressed economy. But then when you point out that recovery has still left output and employment well below their pre-crisis levels, you’re told that those levels weren’t sustainable anyway. Do you see the problem? The apologists, by claiming that the pre-crisis peak isn’t a realistic goal, are also claiming that Latvia has never been that deeply depressed an economy in the first place.
Do you see the problem with Krugman’s logic? No, I don’t mean the strawman argument, always a favorite of his. I mean the other glaring problem with his logic. By claiming that the pre-crisis peak is a realistic goal and represented sustainable growth, he is also claiming that there was never an unsustainable boom in the first place. Yes, he does call it a “bubble,” but then effectively declares that it wasn’t a bubble at all by suggesting that it was sustainable growth, which, by definition, would not be a bubble. Just another Krugman Kontradiction.
This is insightful into a key difference between the Austrian and Keynesian schools of thought. To Krugman and other Keynesians, the problem is the bust, and the solution prescribed by them is to do the same things that caused the boom that preceded it to create another one, such as continuing to run the printing presses and keeping interest rates down. To Austrian economists, on the other hand, the problem is the artificial boom representing unsustainable growth brought about by artificially low interest rates, for which the bust is the actually cure; but instead of allowing the market correction, governments intervene in an attempt to reinflate the bubble, such as by continuing to run the printing presses and bailing out the banks, etc., thus preventing the correction from occurring, the malinvestment from being liquidated, and real capital (as opposed to easy credit brought about through monetary inflation) to be reaccumulated, which serves only to prolong the recession and set the stages for the next boom-bust cycle.
Krugman in fact, following the bursting of the dot-com bubble, advocated a Federal Reserve policy of lowering interest rates specifically in order to create a housing bubble. And we all see how well that worked out. Check out my book Ron Paul vs. Paul Krugman: Austrian vs. Keynesian economics in the financial crisis for more on his record. Also check out my recommended books in the “Economics” section of the Foreign Policy Journal store.