Use access key #2 to skip to page content.

TMFMmbop (40.06)

Paul Krugman and the Error of Normalization

Recs

12

August 24, 2009 – Comments (6)

Look, I think the value of the US dollar is going to decline and that we're going to see inflation as a result of current government spending. There's my bias out of the way from the get-go. NY Times persona Paul Krugman somewhat agrees with this stance, but he tried to rationalize a $9 trillion deficit on his blog yesterday, writing:

"What you have to bear in mind is that the economy — and hence the federal tax base — is enormous, too. Right now GDP is around $14 trillion. If economic growth averages 2.5% a year, which has been the norm, and inflation is 2% a year, which is the target (and which the bond market seems to believe), GDP will be around $22 trillion a decade from now. So we’re talking about adding debt that’s equal to around 40% of GDP."

Now, 2.5% annual GDP growth over the next 10 years with just 2% inflation would be a spectacular accomplishment. That's a very optimistic scenario, in my mind. Yet Krugman, just the day before, wrote this on his blog:

"The stimulus has helped, and the conventional recession is over. But the economy is not recovering in the most crucial area, job creation, and the stimulus won’t be enough to restore prosperity."

My thought is that 2.5% GDP growth would mean that prosperity has been restored, which means these posts must each exist in their own little vacuum in order for them to hang together. Yet they were written on the same blog, by the same guy, one day apart. Must be fun to be an economist!

The broader point, however, is in the error of normalization, which people make all of the time. As Nassim Taleb has pointed out time and time again, the world won't grow a steady 2.5% each and every year for the next 10. There will be significant swings, which will cause significant volatility. And we problem don't want to be holding so much federal debt when those swings happen, IMO.

Similarly, when we look back in 50 years long after this housing crisis has passed, we're probably going to annualize out this "blip" and say that housing prices increase 2% a year. And while that's true, that doesn't mean you should lever up expecting 2% returns each and every year. As we've seen, reality is volatile and people who normalize are stupid.

6 Comments – Post Your Own

#1) On August 24, 2009 at 3:50 PM, starbucks4ever (97.89) wrote:

Wow! It didn't even occur to Crookman that his scenario would only possible if the debt had a 0% interest. And this guy was given a Nobel Prize!

Report this comment
#2) On August 24, 2009 at 4:00 PM, TMFRoyal (97.39) wrote:

And economists have predicted 9 of the last 5 recessions.

Report this comment
#3) On August 24, 2009 at 4:32 PM, silverminer (30.49) wrote:

Yeah, Krugman's self-conflicting positions and fantastical use of imaginary metrics never ceases to amaze me.

Lacking any realistic data to back his positions, I can only presume that much of his rhetoric is politically motivated.

Report this comment
#4) On August 24, 2009 at 4:37 PM, Deepfryer (27.86) wrote:

"My thought is that 2.5% GDP growth would mean that prosperity has been restored, which means these posts must each exist in their own little vacuum in order for them to hang together."

Uh, no. He predicted 2.5% GDP growth over the next ten years. That certainly doesn't mean that prosperity has been restored as of today.You're just making faulty assumptions to try and make it look like he contradicted himself. But he didn't.

Regarding normalization, that's another topic altogether and probably should've been made in a separate post. But either way, he was just making a prediction based on a typical figure for GDP growth. You're really stretching your imagination if you think he's an idiot.

By the way, on the Motley Fool homepage there is a huge banner that says:

"Stock Advisor

Beating the S&P 500 by 41.28%"

But, as we've seen, reality is volatile and people who normalize are stupid. Right?

Report this comment
#5) On August 24, 2009 at 4:47 PM, TMFMmbop (40.06) wrote:

@Deepfryer. The quote pretty clearly says "If economic growth averages 2.5% a year." That means an average of 2.5% growth each and every year for the next 10, or 28% cumulative growth in GDP over the next decade.

You're entitled to your own opinion, but you're not entitled to your own facts.

Report this comment
#6) On August 24, 2009 at 5:00 PM, eddietheinvestor (< 20) wrote:

Krugman bases his economic theories on politics.  He seems unable to separate the two.  If Obama raises the debt to 9 TRILLION dollars, Krugman will find a way to say that the debt is not a problem.  It is no different than Biden saying that we need a stimulus because spending money is the best way to avoid debt and bankruptcy.  Both Krugman and Biden are liberals who see economics through a liberal lens; this bias is their right and is part of free speech, but articles by and about them should note this, just as articles involving Limbaugh mention his conservate bias.

Report this comment

Featured Broker Partners


Advertisement