Diary

Dr. Krugman, Step Away From the Kool-Aid...

To the surprise of absolutely nobody, Dr. Paul Krugman has echoed the call of the left for Porkulus Round II.  He does so in the Print Media Organ of The Democratic Paty, the New York Times, in a July 10 op-ed piece.

To be fair to Dr. Krugman, I will say that there are areas where we agree (and please, let me finish before brandishing the torches and pitchforks):

1. In other recessions, monetary policy was a sufficient tool to expand liquidity such that, after a lead time (generally two or three quarters), demanded output picked up and growth resumed.

2. In this recession, monetary policy ran out of gas when interest rates went to zero (the “liquidity trap”).

3. Porkulus I isn’t working and will not, in and of itself, work.

This is the end of the lovefest.  Dr. Krugman takes a big gulp of the left’s Kool-Aid and calls for Porkulus Round II.  I am of the view that when you’ve dug yourself deep into a hole, perhaps you might want to put the shovel down.

What, and more importantly who, isn’t working during this downturn is going to be the key to growth restarted.  I’m going to make a really, really radical suggestion to get unemployment down that will most likely get me sent to a re-education camp:

Supply-side tax cuts (insert gasp of horror from the left here…).

(In the interests of full disclosure, I’m actually a proponent of an economy-wide reduction in the marginal tax rate, but in light of this week’s release of a record high Continuing Claims number, I’ll talk about putting workers back to work vs. improving the discretionary income of those with jobs).

How does a supply-side tax cut put people to work?  Here’s how:

1. In the simplest incarnation of the business pricing model, the supply side sets aggregate pricing as wages paid multiplied by a markup factor.  The markup factor reflects the cost of doing business which includes taxes.  Put in another form, real wages (wages divided by aggregate prices) are the inverse of the markup factor – reduce costs (fiscal policy helps this by reducing taxes on the supply side) and real wages go up.

2. The wages demanded by workers is modeled by aggregate prices multiplied by a function of unemployment.  This function is a decreasing function of unemployment – when there are more workers competing for jobs, both job seekers and incumbents demand less pay to get and retain scarce jobs.  Real wages, as defined previously, are equal to this function.

The labor market clearing point is the point at which real wages determined by supplier pricing equals those determined by the labor market condition function.

So this is how a supply-side tax cut puts people to work: Reduce costs to business, and the real wages as affected by pricing increases, and will do so by reducing prices.  More employers can offer, and employees accept, lower nominal wages than they would at the higher cost/markup as a) employers have more capital to use to expand and b) lower prices gives these wages a higher real wage. Everybody wins (except for Pelosi’s mouse in San Francisco, but that’s another story…).

There are some assumptions here – the biggest of which is that “government” (both the fiscal and monetary sides) doesn’t set off hyperinflation by creating and/or monetizing huge debt.  Perform that act of stupidity (by maybe, uh, passing Porkulus Round II) and the “reduce unemployment by increasing real wages” task becomes an impossibility.

But far be it from me to argue with the esteemed Dr. Krugman.