Much Too Responsible

_Paul Krugman

The United States and Europe have a lot in common. Both are multicultural and democratic; both are immensely wealthy; both possess currencies with global reach. Both, unfortunately, experienced giant housing and credit bubbles between 2000 and 2007, and suffered painful slumps when the bubbles burst.

Since then, however, policy on the two sides of the Atlantic has diverged. In one great economy, officials have shown a stern commitment to fiscal and monetary virtue, making strenuous efforts to balance budgets while remaining vigilant against inflation. In the other, not so much.

And the difference in attitudes is the main reason the two economies are now on such different paths. Spendthrift, loose-money America is experiencing a solid recovery — a reality reflected in President Obama’s feisty State of the Union address. Meanwhile, virtuous Europe is sinking ever deeper into deflationary quicksand; everyone hopes that the new monetary measures announced Thursday will break the downward spiral, but nobody I know really expects them to be enough.

On the U.S. economy: No, it’s not morning in America, let alone the kind of prosperity we managed during the Clinton years. Recovery could and should have come much faster, and family incomes remain well below their pre-crisis level. Although you’d never know it from the public discussion, there’s overwhelming agreement among economists that the Obama stimulus of 2009-10 helped limit the damage from the financial crisis, but it was too small and faded away far too fast. Still, when you compare the performance of the American economy over the past two years withall those Republican predictions of doom, you can see why Mr. Obama is strutting a bit.

Europe, on the other hand — or more precisely the eurozone, the 18 countries sharing a common currency — did almost everything wrong. On the fiscal side, Europe never did much stimulus, and quickly turned to austerity — spending cuts and, to a lesser extent, tax increases — despite high unemployment. On the monetary side, officials fought the imaginary menace of inflation, and took years to acknowledge that the real threat is deflation.

Why did they get it so wrong?

To some extent, the turn toward austerity reflected institutional weakness: In the United States, federal programs like Social Security, Medicare and food stamps helped support states like Florida with especially severe housing busts, whereas European nations in similar straits, like Spain, were on their own. But European austerity also reflected willful misdiagnosis of the situation. In Europe as in America, the excesses that led to crisis overwhelmingly involved private rather than public debt, with Greece very much an outlier. But officials in Berlin and Brussels chose to ignore the evidence in favor of a narrative that placed all the blame on budget deficits, and simultaneously rejected the evidencesuggesting — correctly — that trying to slash deficits in a depressed economy would deepen the depression.

Meanwhile, Europe’s central bankers decided to worry about inflation in 2011 and raise interest rates. Even at the time it was obvious that this was foolish — yes, there had been an uptick in headline inflation, but measures of underlying inflation were too low, not too high.

Monetary policy got much better after Mario Draghi became president of the European Central Bank in late 2011. Indeed, Mr. Draghi’s heroic efforts to provide liquidity to nations facing speculative attack almost surely saved the euro from collapse. But it’s not at all clear that he has the tools to fight off the broader deflationary forces set in motion by years of wrongheaded policy. Furthermore, he has to function with one hand tied behind his back, because Germany remains adamantly opposed to anything that might make life easier for debtor nations.

The terrible thing is that Europe’s economy was wrecked in the name of responsibility. True, there have been times when being tough meant reducing deficits and resisting the temptation to print money. In a depressed economy, however, a balanced-budget fetish and a hard-money obsession are deeply irresponsible. Not only do they hurt the economy in the short run, they can — and in Europe, have — inflict long-run harm, damaging the economy’s potential and driving it into a deflationary trap that’s very hard to escape.

Nor was this an innocent mistake. The thing that strikes me about Europe’s archons of austerity, its doyens of deflation, is their self-indulgence. They felt comfortable, emotionally and politically, demanding sacrifice (from other people) at a time when the world needed more spending. They were all too eager to ignore the evidence that they were wrong.

And Europe will be paying the price for their self-indulgence for years, perhaps decades, to come.

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