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I have several issues with the article.

1. I rather doubt that Krugman's entire view of the economy is the Circular Flow Model put forth by Murphy.

2. Murphy's criticism is itself based on a model that's wildly incomplete. There are numerous other factors, such as demographic trends, that also have relevance to savings, investment, demand, etc. and might be related to a possible Paradox of Thrift.

3. Murphy seems to have missed the fact that the economic activity is far less dependent on long term tangible capital goods than it once was and those capital goods are faster and cheaper to produce. Tools for plastic parts can be turned around in weeks (or faster). It is true that the machines to create tools have a longer life span, but there is excess capacity for that class of capital at the moment.

3. The entire service economy is rather like masseuses in that relatively little capital is required for most of it.

4. You are correct that "it is incorrect to assume that all saving is automatically invested in future production". In fact, it's exactly opposite. Savings only really occurs when an investment in future production is made. Otherwise, savings is just a flow back into the infinite pool of fiat money which is rather useless.

I don't think that the Paradox of Thrift has been a significant factor in any past U.S. recession (depression). It may not have anything to do with the current one either and I'm not at all convinced that increased government deficit spending is the right thing to do at this point.

However, the Paradox of Thrift certainly could be a factor at some point.

Same old theory of investment versus consumption, of leads and lags, of endogenous and exogenous.
Truth is, if you look at the historical record, consumption and investment evolve in a parallel way. So there must be some causality.

Where does investment come from?
What statistical analysis and econometric studies show, in their vast majority, is that we have an accelerator model, i.e. investment is induced by consumption and consumption expectations. This is true on average in long time series inquiries.
Is the current downturn any exception? Hard to tell. On one hand it all started with the collapse of residential investment so I wouldn't be surpised to see total investment collapse before consumption (I'm not sure about the numbers). But on the other hand, it is fair to say that this is a credit crisis and that the credit restrictions have hurt consumption more than it has hurt investment. I think the consumption problem is much more acute than the investment problem.
In all likelihood investment will follow consumption. If there is anything called exogenous investment, I don't see where it could come from in the present context --except of course, government investment driving private investment *somehow* or quite possibly a dollar depreciation.
But we do have a theory of consumption and investment, it's called the accelerator, and it works beautifully in applied work. Personally, I wouldn't align with the Austrians in here.

Still seems to me that if the government gives consumers a handout in the form of tax breaks or cash, it helps consumers feel more confident in the future and also helps recapitalize the banks when consumers save or pay down debt instead of spending it. Consumer confidence restores desire of entrepreneurs to invest, while stronger banks give them the ability to invest.

Good discussion. In effect, I think Krugman is calling for increased investment (what you would term "saving") in infrastructure.

Krugman says: "No, what the economy needs now is something to take the place of retrenching consumers. That means a major fiscal stimulus. And this time the stimulus should take the form of actual government spending rather than rebate checks that consumers probably wouldn’t spend."

1. Improved infrastructure would theoretically increase the productivity of society with better roads and rail, improved telecom networks, more efficient power grids, educational grants, etc, which would take the place of consumer spending as an input into the economy.

2. Deficit spending to import TV's and microwaves is lunacy. The fact that nobody is buying cars and TV's can be viewed as a positive: the manufactured goods on the market and in peoples' homes are better quality and lasting longer. Do we really need/want 17 million new cars every year to eventually go to landfills?

3. Tax breaks to industry sound great, but if they are not producing any profits, then they are not paying taxes anyway (look at JPM's or GM's year-end tax bill for instance.) This would not lead to any increase in employment by my reckoning.

The case against Krugman has not been made very strongly, IMHO.

Olivier,

Would you mind providing a link or two (or the titles and authors) for the econometric time series studies you think are the most definitive? I use Google Scholar frequently for such research, and would like to investigate the papers you mentioned.

Thanks,
Steve

Steve,

I get the part about investing across the board. But, tell me. Are not corporations that, in the past, used excess cash to buy back stock guilty as well? I understand about capitalization and how the tax code can hinder reinvestment. Nevertheless, it appears to me that a going concern should use free cash flow to invest in R&D. os use it for capex to grow or to
either create new demand or differentiate themselves from the competition. Certainly buying back stock is not what I'd call investing in growth.

Your comments?

Bob,

You're right; stock buybacks are financial plays. How a company chooses to utilize its cash can be a bellwether. The old adage "growth consumes cash, liquidation generates cash" could be a warning sign for companies buying back their own stock.

Needless to say, a lot of companies now wish they hadn't done it last year. They handed over trillions in shareholder value to the short sellers.

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