Krugman’s Bathtub Economics

Tyler Durden's picture

Submitted by David Stockman of Contra Corner blog,

You often find people talking about our economic difficulties as if they were complicated and mysterious, with no obvious solution. As the economist Dean Baker recently pointed out, nothing could be further from the truth. The basic story of what went wrong is, in fact, almost absurdly simple: We had an immense housing bubble, and, when the bubble burst, it left a huge hole in spending. Everything else is footnotes.

And the appropriate policy response was simple, too: Fill that hole in demand.

True enough, the housing and credit bubbles did burst. But that’s exactly where the rubber meets the road in the debate between Keynesians and Austrians. The latter see bubbles as an artificial expansion of economic activity owing to cheap credit and the malinvestments which flow from it.

When bubbles inevitably burst, therefore, the artificial bloat in investment, output, jobs and incomes is eliminated—or in the old fashioned phrase, liquidated.  Moreover, liquidation is the equivalent of purging a cancer; it removes a malignant growth, but does not reduce the true wealth of society or the sustainable living standard of the people.

The reason for this proposition is Say’s Law. That is, sustainable demand must originate in production; valid “spending” must be derived from the income earned in the process of supplying real goods and services. That includes spending that is financed by savers out of their own current incomes, and spending by transfer payment recipients that is financed by taxes on producers.

In that context, “money” is just an intermediary: it facilitates efficient exchanges between producers, but does not give rise to incremental “demand” that is independent of goods and services already delivered. Accordingly, when a credit bubble bursts there is no loss of honest, production-based aggregate demand. What disappears is artificial monetary demand that was originally enabled by the central bank and the financial system, not the productive main street economy.

Self-evidently, therefore, there was no “hole’” to fill after the housing and credit bubbles imploded in 2008. So Krugman’s injunction to “fill that hole” implies the opposite of Say’s Law. Namely, it embraces the Keynesian notion of what might be termed the “conservation of demand”. Accordingly, spending originating in fiat credit must always and everywhere be preserved by the fiscal and monetary arms of the state via new injections of artificial, non-production based “demand”.

It does not take too much imagination, however, to see where that leads—straight to helicopter money. During the seven years ending on the eve of the financial crisis in Q3 2008, total credit market debt soared from $28 trillion to $53 trillion—-or at a sizzling 9.2% annual rate.

By contrast, nominal GDP during the same period expanded at just 4.8% annually or at half the rate of credit growth. Accordingly, just during this short 7-year interval, the nation’s aggregate leverage ratio expanded from 2.7X GDP to 3.5X. In short, the booming “demand” of the Greenspan/Bernanke housing bubble was being borrowed from the future, not financed out of current production.

The unsustainability of nominal GDP growth financed by an ever increasing ratchet of the leverage ratio is evident from simple arithmetic. Just assume that the massive credit expansion of 2001-2008 was a good thing and that the trend needed to be preserved another 7-years, according to the Keynesian injunction on the conservation of demand. Moreover, even though credit expansion was rapidly loosing its efficacy during the last bubble as more debt bought less new GDP each year, assume that nominal GDP also managed to grow at 4.8% a year— compared to the actual rate of only 2.4% annually that has been recorded since 2008.

Under those assumptions, a “cut and paste” of the 2001-2008 trend would result by 2015 in $100 trillion of credit market debt on $20.6 trillion of GDP. The national leverage ratio would then also ratchet to  a mind-numbing 4.8X GDP.

Needless to say, the credit-fueled trend of 2001-2008 could not be sustained without eventual economic and financial collapse. Stated differently, the rate of demand growth from the Greenspan/Bernanke bubble finance policies could not be conserved, and should not have been implemented in the first place.

Ironically, the housing bubble that Professor Krugman wants to preserve was actually his idea in the first place. During 2002 he famously instructed the Fed to replace the dotcom bubble with a housing bubble. Now he proposes that the “hole” left by the housing collapse should have been filled by an aggressive expansion of public investment, which is to say, a public works bubble.

In particular, the aftermath of the bursting bubble was (and still is) a very good time to invest in infrastructure. In prosperous times, public spending on roads, bridges and so on competes with the private sector for resources. Since 2008, however, our economy has been awash in unemployed workers (especially construction workers) and capital with no place to go (which is why government borrowing costs are at historic lows). Putting those idle resources to work building useful stuff should have been a no-brainer.

But what actually happened was exactly the opposite: an unprecedented plunge in infrastructure spending. Adjusted for inflation and population growth, public expenditures on construction have fallen more than 20 percent since early 2008. In policy terms, this represents an almost surreally awful wrong turn; we’ve managed to weaken the economy in the short run even as we undermine its prospects for the long run. Well played!

Here is the part that Professor Krugman didn’t mention. We already had a public works bubble last time around! Public construction spending grew at a 10% annual rate in the period up to the 2008 crash.  The decline he laments since then is modest, and still reflects a 2% real growth rate since the 1990s. Filling the “hole” with a continuation of the pre-2008 public works bubble, therefore, would result in the same kind of malinvestments and waste that was generated by the housing bubble he recommended last time around.

Here is the same data in constant dollars. Given the pork barrel nature of public works spending, it is completely unlikely that the public works bubble recommended by Professor Krugman would actually add to national wealth and living standard.  But it would fill up the Keynesian bathtub, and that is, apparently, exactly what Krugman seeks to accomplish.

Real Public Construction Spending- Click to enlarge


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So Close's picture

Can we re-enstate the law that allows folks to be tarred and feathered in the town square?

Winston Churchill's picture

The 'ducking chair" is prolly still on the books somewhere in the US.

Govt. rarely repeals laws.

I would love Krugman to be declared mortem of course.

Would that be enough liquidity for him ?

knukles's picture

Way back when, dunces, idiots, morons, the weak minded, demented, insane, tetched, disturbed and diseased in some quarters (thinking ancient Rome, especially during the good olde days of Caligula) were used primarily for public entertainment.

remain calm's picture

If Krugman is in the bathtub then his loofah is way up his ass.

Say What Again's picture

How did the Krugman-Asshole ever get a PhD?  Doesn't he have to "defend" his thesis in front of a bunch of "learned" professors?  Which professors felt he had made a decent presentation of rational thought?

Beam Me Up Scotty's picture

You mean the professors that work at colleges who are dependent on .gov??? They gave him an A, because they are all involved in the same circle jerk!!

Squid-puppets a-go-go's picture

Is anyone in the MSM cluey enough to ask why dont we fix the holes in the bath, rather than continuing to pour liquidity into a broken recepticle?

You could write a whole thesis on why Krugman is wrong, but its already been summed up perfectly by that song

'there's a hole in the bucket, dear Liza dear Liza'

centerline's picture

You ever deal with PhD types?  Most in my profession are near useless in the real world.

Reaper's picture

All you need do is kiss rears, pay your fees and spend the time. After three years or more, it easy to learn the correct jargon to sound as educated as your professors. Graduate school is a hustle which needs paying suckers to survive.

All Risk No Reward's picture

>>You often find people talking about our economic difficulties as if they were complicated and mysterious, with no obvious solution. As the economist Dean Baker recently pointed out, nothing could be further from the truth. The basic story of what went wrong is, in fact, almost absurdly simple: We had an immense housing bubble, and, when the bubble burst, it left a huge hole in spending. Everything else is footnotes.<<

Except this is wrong.

We didn't just pull a housing bubble out of our *ss.

The Debt Money Tyrants criminally blew the world's largest credit bubble contrary to the law as written in Section 2A of the Federal Reserve Act...

Weapons of Mass Debt

The latest chart update is here...

Our debt base monetary system is a complete and total fraud engineeted to do exactly what it is doing...  BANKTUPTING SOCIETY.

Debt Money Tyranny

Until one understands this fact, one is clueless...

Debunking Money - How the world really works

Renaissance 2.0 - Financial Empire

How to be a Crook

Hugh G Rection's picture

I'd be happy if they re-enstated dueling.  Aaron Burr knew how to deal with bankster lackeys.

Actually 4 days from the 210th anniversary, don't forget to celebrate by shooting a $10 bill.

Winston Churchill's picture

Instated.Same in American I believe.

Let it go on the other thread, sorry just niggles a second time..

Pairadimes's picture

It should be legal to hit people like him in the head with a fireplace poker.

nmewn's picture

Even if not legal, its still justice ;-)

Caviar Emptor's picture

Sorry. It melted up, it will melt down. Despite Fed money printing, the economy will founder. As a matter of fact because of it. Because you can create inflation in the midst of economic collapse, if you're "smart" (like the Fed heads). If you believe in the Laffer Curve, trickle down economics and in financialization, like In the Reagan days, then it's a given that it all ends up like what we have now: biflationary collapse.
But wait there's more. Killing the middle class also guts national spirit. So the barbarians at the gates will eventually have little resistance. Checkmate

Colonel Klink's picture

Krugman jizzed in the bathtub.

Freedumb's picture

Exactly the same sort of bathtub problem in the tulip market. As I see it, the tulip bathtub is maybe only 0.5% full at best compared to some past valuations I've seen.

How's a man supposed to retire at these levels of tulip valuation?


Australian Economist's picture



Keynesian idiots, no one gets rich through spending all their money. The road to prosperity is paved with savings and productive investment.

XitSam's picture

They aren't spending their money, they're spending money that never before existed! So everything's fine. See how easy things are when you accept Keynes into your life?  /s btw

Australian Economist's picture

They are not spending their money they are spending ours, indebting us and our children to a life of debt slavery. They may create the money out of thin air but they are making a promise that YOU pay it back.

NidStyles's picture

It will be amusing to see a bunch of lawyers and bankers in their suits coming to collect from the public. 

Australian Economist's picture

They don't need to collect, they have the handy trick of inflation, so no one gets hurt...until they do.

All Risk No Reward's picture

And counting the theft as GDP!

These are some audacious b*stards that are convinced we are idiots who understand nothing of the system in play...  and they are pretty much right...  and the people that do know are given incentives to shut up about it.

stant's picture

I still have my trillion$ coin I got on ebay to remind me (in his honor )what full retard is

deflator's picture

"never go full retard" is for us. The government always goes full retard by default.

SilverIsMoney's picture

When mobs start hanging people in New York I hope they start with him... followed by Bloomberg.

Whatta's picture

the bubbles in Kruggies tub are from his burrito at lunch.

aleph_0's picture

I'd nearly forgotten about that fella.

deflator's picture

Why not just cut to the chase and simplify in one paragraph?

The Central State intentionally blew a bubble in RE and everything else--popped it--then filled in the missing demand with it's needs wants and desires of equalizing everything on the basis of race, gender and sexual orientation.

I Write Code's picture

To each, according to his needs.

As determined by your voting record and ethnicity.

crazytechnician's picture



Krugman: Debt is Wealth , smash some windows borrow money to fix windows - GDP expands , in fact , naa , fuckit let's just nuke each other's cities and kill off complex life forms from radiation that would be much more productive than breaking few windows , give or take a few million years.


Filling the punchbowl so that it spills over the table and
cascades down the hall and down the stairs to fill up the second floor bathtub, Professor Krugman? This is trickledown
that evaporates before it makes it to the bathtub in the first place. Keynes did not account for Liberal largesse
and routine kickbacks. Hoover Dam saved the USA during the
30s depression era and it is doubtful that kickbacks were paid to keep the job going. Accounting and Engineering were honest back then and auditors were as well. Today, everyone
is paid off and kickbacks are a part of all municipal, state/province, or federal projects. Throwing taxpayer dollars at BIG government waste no longer makes good business sense and Keynes was bright enough to see that IMHO. TARP was spent on the stock market and the banks invested in EM. Keynesian remediation has not actually occurred if these US dollars were spent elsewhere, eh.

MilwaukeeMark's picture

Those who can do. Those who can't, write for the New York Times.

nathan1234's picture

Tyler - Dont spoil my bath

Kindly call it what it deserves.

Toilet Economics where Krugman's crap goes down

AdvancingTime's picture

Massive deficits have been propelling the economy forward, and it is not sustainable. Please note; Greatly compounding the problem is the realization that most people like infants, children, the disabled or unemployed could not pay their share if their life depended on it, this transfers the burden to the remainder of society.

Making the ugly math simple to understand is no easy task, the article below has a go at it. Not lying about the numbers to arrive at a clear picture of reality is important. Most Americans would be shocked at just how deep the debt is stacking up,


AdvancingTime's picture

During the "boom times" when asset values are going up lots of people think they are getting rich. In inflationary times government also does well as tax revenues grow. Not only does government get to spend the money they print, the side effects of inflation on taxes are good for government, though bad for their subjects.

By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. said John Maynard Keynes. As the central banks print like crazy to control interest rates on bonds they devalue the currency.

While there are not many Bond Vigilantes there are many Currency Vigilantes. Changes in the value of a currency directly affect "buying power" and the value of assets. Inflation, deflation, what is something worth? More on this subject in the article below.

d edwards's picture

Bathtubs? Bubbles? Oh, I get it: we're in a "bubble" bath. You can drown in a bathtub ya know.


This pretty much proves the Krugerman is of his rocker.

Analyse2's picture

@d edwards

Bathtubs? Bubbles? Oh, I get it: we're in a "bubble" bath



yanush's picture

To understand better what is going on with our economy and whether  Prof. Krugman and  his supporters recommendations can boost the economy  read the following papers by C.Yanushevsky and

R .Yanushevsky “ Spending and Growth: A Modified Debt to GDP Dynamic Model “ and “Is Infrastructure Spending an Effective Fiscal Policy?” (Metroeconomica, Vol. 65, Issue 1, pp. 123 135, 2014; International Journal of Economic Sciences and Applied Research, Vol.6, Issue 3, pp. 21 33, 2013).