The Age of Diminished Expectations,
Third Edition: U.S. Economic Policy
in the 1990s by Paul Krugman
Flexible Labor Markets Made Room For All The New Entrants And Limited Wage
Increases To Rates Consistent With Slow Productivity
The Age of Diminished Expectations is a remarkable achievement, a quick
read that tells you much of what there is to know about the great
economic issues of the day. -- Peter Passell, New York Times Book
Review Paul Krugmans popular guide to the economic landscape of the
1990s has been revised and updated to take into account economic
developments of the past three years. New material in the third edition
includes: A new chapter--complete with colorful examples from Lloyds of
London and Sumitomo Metals--on how risky behavior can lead to disaster
in private markets. An evaluation of the Federal Reserves role in reining
in economic growth to prevent inflation, and the debate over whether its
growth targets are too low. A look at the collapse of the Mexican peso
and the burst of Japans bubble economy. A revised discussion of the
federal budget deficit, including the growing concern that Social Security

and Medicare payments to retiring baby boomers will threaten the
solvency of the government. Finally, in the updated concluding section,
the author provides three possible scenarios for the American economy
over the next decade. He warns that we live in an age of diminished
expectations, in which the voting public is willing to settle for policy drift--
but with the first of the baby boomers turning 65 in 2011, the U.S.
economy will not be able to drift indefinitely.
Personal Review: The Age of Diminished Expectations, Third
Edition: U.S. Economic Policy in the 1990s by Paul Krugman
1. In Europe between 1973 and 1985 there were no job creation and
unemployment increased fivefold.
2. The high unemployment meant that productive workers were not being
used preventing the economy to grow.
3. The principle fear of low unemployment is that it will cause inflation to
increase. If the government wants to reduce the inflation rate, it must
reduce demand so as to drive unemployment above this rate, termed "the
no accelerating inflation rate of unemployment." NAIRU is an example of
the economy where the government is trying to keep employment high by
keeping demand high. The problem is a labor shortage causes higher
premiums to be paid for skilled labor. The government must accept an
unemployment rate that is sufficiently high on the average demand to real
wages do not exceed their productivity growth, and firms do raise their
prices faster than their costs. Work productivity must be the determining
factor for real wages.
4. Which is more serious problem 6 percent unemployment or 5 percent
inflation? The trend tendency is for inflation to rise while unemployment is
low. Paul Krugman says, "America's highly competitive and flexible labor
markets made room for all the new entrants and limited wage increases to
rates consistent with our slow productivity growth."
5. If we spend more on imports than foreigners spend on our exports, the
result is reduced demand for American labor.
6. The trade deficit has a cost, a gradual mortgaging of future US income
to foreigners. When we buy more foreign goods than we sell, we must
cover the cost by selling them assets: stocks, bonds, real estate, and
whole corporations to foreigners.
7. Financial obligations to foreigners means the US will be obligated to
deliver a stream of interest payment to foreign bondholders and dividends
to foreign stockholders. The payments to foreigners are a direct drain on
our resources. The big risk is the US could be exposed to financial crisis
whenever the confidence of foreign investors is shaken, the confidence
game.
8. In 1980, US national savings began to fall sharply. Amazingly, US
national savings in 1980 was over 10 percent, a healthy percentage. The
consumer increased consumption of foreign goods using borrowed money.
The trade deficit spending was financed by the selling of assets to
foreigners and not US national savings. In 1980s, US National saving fell,
consumption spending increased, inflows of foreign investment took the

place of domestic saving. The US was importing more than it was
exporting.
9. In the 1980s, if US investment demand was funded by US national
savings then interest rates would have increased because saving amounts
fell short of investment demand. The US became dependant on foreign
capital to finance investment and foreign inflows of capital financed the
debt. Interest rates rose, dollar dominated assets became attractive to
foreigner, and the dollar gained strengthen against other currencies. The
decline of National savings led to a massive importing of debt.
10. Should the value of each currency be determined by a gold standard?
Today, debt has replaced gold as the debt reserve. The federalist
preached credit was necessary for a prosperous economy. However, debt
impoverished with the debt weight of interest and dividend payments.
11. A reduction in the trade deficit in the US will result in recessionary
pressures domestically and inflation abroad.
12. The exchange rate determines capital flows and changes in the trade
balance. A weak dollar cause exports to increase and strong dollar causes
imports to increases in general terms.
13. If the Fed expanded the supply of money, the dollar would have
become weaker, short-term exports increased, and inflation.
14. The solution is to switch the demand for foreign goods to US goods.
The way the government does accomplishes this goal is by reducing the
value of the dollar (inflation), imposing tariffs and quotas, and a policy to
reduce domestic demand, so the expenditure switching policies don't feed
inflation.
15. Inflation reduces the competitiveness of industrial companies at any
given exchange rate. Inflation causes US prices to raise in equal
proportion to the decline of the dollar and this affects US competitiveness.
16. Lower imports will mean a lower supply of dollars on the foreign
exchange market and a stronger dollar. The rise of the dollar would cut
exports.
17. Given the diminishing expectations of the American people, getting
inflation down to a point where prices double every 15 years is good
enough.
18. The harm of inflation is that prices are constantly changing which can
distort decisions and reduce economic efficiency. Inflation causes paper
gains for owners of assets and so inflation may discourage saving and
capital formation and increase taxes. Inflation may create capital losses,
reduced taxes, and encourages corporate debt. Investors have difficulty
determine profits and losses that are inflationary illusions.
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