Krugman and Bubble-Mania

Krugman had good column today on the weak long term prospects for our economy and our desperation for another bubble.  Here is the comment on I posted.

I agree, we appear to be bubble-addicted and bubble-reliant.  This is largely because our understanding of the economy insists that “growth” is the single criterion of economic health.  But as any investor knows, growth must be adjusted for risk to capture true return.

Almost all of the concepts we use to measure and describe the economy are measures of or references to transaction volume: gross domestic product, recession, stimulus, balance of payments etc.  When people say “the economy” is in trouble, they mean “transactions are down.”  When people say they are hopeful about an economic turn-around, they mean “I can see transactions increasing in the future.”

There are no strict measures of national economic volatility.  We carefully measure and debate whether we are in a “recession,” but not so whether we are in a “bubble.” Thus, even though there are times when volatility reducing recessions would be preferable to volatility increasing bubbles, we lack the tools to argue for this choice.  Recessions, we believe, must be avoided, and if the way to avoid them is by encouraging bubbles, so be it.  If you lose money at the track, try hitting the slots on the way out to “win it back.”

It is possible that, at one time, interest rates could have served the role of volatility monitors, but in the era of active management of the money supply (to serve growth) interest rates are tools of economic management rather than outcomes of economic performance.  For example, the low rates of the last five years clearly did not reflect the risk in the economy.

The recent attention to contributions by sector (e.g. how much of GDP comes from consumption, how much of profit growth comes from financial services) shows we are beginning to look in the right direction, but a more formal recognition and treatment of the topic is required.  Similarly, the long standing criticisms of economic policy by those concerned with environmental degradation and sustainability are informed by the same concern but tend to be stated in moral, rather than economic, terms.  Their arguments thus implicitly suggest that the growth-at-all-costs champions have the economic high ground.  They do not.

Put simply, some forms of growth are better than others.  Growth in the ability to efficiently satisfy deep human needs is likely to be stable, as those needs aren’t going to change, and is therefore productive.  But growth in the ability to tap the moods of the moment is not really useful at all.  It allocates scarce resources to industries and skills of short-lived application, sowing the seeds of future crashes.  This, more volatile growth, is economically inferior and should be treated by policy as such.