Paul Krugman: Nobody Understands Debt

Austerity has been a disaster:

Nobody Understands Debt, by Paul Krugman, Commentary, NY Times: ...Last week, the McKinsey Global Institute issued a report titled “Debt and (Not Much) Deleveraging,” which found, basically, that no nation has reduced its ratio of total debt to G.D.P. ...

You might think our failure to reduce debt ratios shows that we aren’t trying hard enough — that families and governments haven’t been making a serious effort to tighten their belts, and that what the world needs is, yes, more austerity. But we have, in fact, had unprecedented austerity. ...

All this austerity has, however, only made things worse — and predictably so, because demands that everyone tighten their belts were based on a misunderstanding of the role debt plays in the economy. ...

Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer). True, debt can pose a threat to financial stability — but the situation is not improved if efforts to reduce debt end up pushing the economy into deflation and depression.

Which brings us to current events, for there is a direct connection between the overall failure to deleverage and the emerging political crisis in Europe.

European leaders completely bought into the notion that the economic crisis was brought on by too much spending, by nations living beyond their means. The way forward, Chancellor Angela Merkel of Germany insisted, was a return to frugality. Europe, she declared, should emulate the famously thrifty Swabian housewife.

This was a prescription for slow-motion disaster. European debtors did, in fact, need to tighten their belts — but the austerity they were actually forced to impose was incredibly savage. ...

Suffering voters put up with this policy disaster for a remarkably long time, believing in the promises of the elite that they would soon see their sacrifices rewarded. But as the pain went on and on... Anyone surprised by the left’s victory in Greece, or the surge of anti-establishment forces in Spain, hasn’t been paying attention.

Nobody knows what happens next, although bookmakers are now giving better than even odds that Greece will exit the euro. Maybe the damage would stop there, but I don’t believe it — a Greek exit is all too likely to threaten the whole currency project. And if the euro does fail, here’s what should be written on its tombstone: “Died of a bad analogy.”